Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

þ  QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

OR

¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             .

Commission file number: 001-14057

KINDRED HEALTHCARE, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   61-1323993
(State or other jurisdiction of
incorporation or organization)
 

(I.R.S. Employer

Identification No.)

680 South Fourth Street

Louisville, KY

  40202-2412
(Address of principal executive offices)   (Zip Code)

(502) 596-7300

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   þ     No   ¨

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

 

Large accelerated filer     þ   Accelerated filer     ¨
Non-accelerated filer     ¨     Smaller reporting company     ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class of Common Stock

 

Outstanding at July 31, 2012

Common stock, $0.25 par value   52,965,232 shares

 

 

 


Table of Contents

KINDRED HEALTHCARE, INC.

FORM 10-Q

INDEX

 

          Page  

PART I.

  

FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements (Unaudited):

  
  

Condensed Consolidated Statement of Operations—for the three months ended June 30,  2012 and 2011 and for the six months ended June 30, 2012 and 2011

     3   
  

Condensed Consolidated Statement of Comprehensive Income (Loss)—for the three months ended June 30, 2012 and 2011 and for the six months ended June 30, 2012 and 2011

     4   
  

Condensed Consolidated Balance Sheet—June 30, 2012 and December 31, 2011

     5   
  

Condensed Consolidated Statement of Cash Flows—for the three months ended June 30,  2012 and 2011 and for the six months ended June 30, 2012 and 2011

     6   
  

Notes to Condensed Consolidated Financial Statements

     7   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     38   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     68   

Item 4.

  

Controls and Procedures

     69   

PART II.

  

OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     70   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     70   

Item 6.

  

Exhibits

     71   

 

2


Table of Contents

KINDRED HEALTHCARE, INC.

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Revenues

   $ 1,535,828      $ 1,292,592      $ 3,115,798      $ 2,485,013   
  

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

     907,106        765,133        1,852,408        1,443,828   

Supplies

     108,238        96,718        219,533        186,740   

Rent

     107,541        95,677        215,509        187,130   

Other operating expenses

     312,995        287,132        623,959        546,501   

Other income

     (2,698     (2,880     (5,446     (5,665

Impairment charges

     329        —          1,196        —     

Depreciation and amortization

     49,802        37,871        98,492        70,420   

Interest expense

     26,716        23,157        53,294        28,885   

Investment income

     (275     (257     (567     (752
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,509,754        1,302,551        3,058,378        2,457,087   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     26,074        (9,959     57,420        27,926   

Provision (benefit) for income taxes

     10,797        (3,419     23,611        12,190   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     15,277        (6,540     33,809        15,736   

Income (loss) from discontinued operations, net of income taxes

     (14     587        96        408   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     15,263        (5,953     33,905        16,144   

(Earnings) loss attributable to noncontrolling interests

     239        421        (212     421   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) attributable to Kindred

   $ 15,502      $ (5,532   $ 33,693      $ 16,565   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts attributable to Kindred stockholders:

        

Income (loss) from continuing operations

   $ 15,516      $ (6,119   $ 33,597      $ 16,157   

Income (loss) from discontinued operations

     (14     587        96        408   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 15,502      $ (5,532   $ 33,693      $ 16,565   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per common share:

        

Basic:

        

Income (loss) from continuing operations

   $ 0.29      $ (0.14   $ 0.64      $ 0.39   

Income (loss) from discontinued operations

     —          0.01        —          0.01   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.29      $ (0.13   $ 0.64      $ 0.40   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Income (loss) from continuing operations

   $ 0.29      $ (0.14   $ 0.64      $ 0.38   

Income (loss) from discontinued operations

     —          0.01        —          0.01   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.29      $ (0.13   $ 0.64      $ 0.39   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in computing earnings (loss) per common share:

        

Basic

     51,664        43,231        51,633        41,145   

Diluted

     51,675        43,231        51,657        41,661   

See accompanying notes.

 

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Table of Contents

KINDRED HEALTHCARE, INC.

CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(In thousands)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Net income (loss)

   $ 15,263      $ (5,953   $ 33,905      $ 16,144   

Other comprehensive income (loss):

        

Available-for-sale securities:

        

Change in net unrealized investment gains

     (199     (116     1,003        438   

Reclassification of net gains included in net income

     (8     (1     (85     (159
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     (207     (117     918        279   

Interest rate swaps:

        

Change in unrealized loss

     (1,132     —          (1,263     —     

Reclassification of losses included in net income, net of payments

     —          —          201        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change

     (1,132     —          (1,062     —     

Income tax expense related to items of other comprehensive income (loss)

     588        41        168        (97
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     (751     (76     24        182   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

     14,512        (6,029     33,929        16,326   

(Earnings) loss attributable to noncontrolling interests

     239        421        (212     421   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) attributable to Kindred

   $ 14,751      $ (5,608   $ 33,717      $ 16,747   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

4


Table of Contents

KINDRED HEALTHCARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

(In thousands, except per share amounts)

 

     June 30,
2012
    December 31,
2011
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 37,566      $ 41,561   

Cash—restricted

     5,422        5,551   

Insurance subsidiary investments

     75,922        70,425   

Accounts receivable less allowance for loss of $30,390—June 30, 2012 and $29,746—December 31, 2011

     1,060,462        994,700   

Inventories

     31,248        31,060   

Deferred tax assets

     24,101        17,785   

Income taxes

     6,361        39,513   

Other

     35,438        32,687   
  

 

 

   

 

 

 
     1,276,520        1,233,282   

Property and equipment

     2,108,365        1,975,063   

Accumulated depreciation

     (998,198     (916,022
  

 

 

   

 

 

 
     1,110,167        1,059,041   

Goodwill

     1,088,379        1,084,655   

Intangible assets less accumulated amortization of $27,382—June 30, 2012 and $16,581—December 31, 2011

     436,123        447,207   

Assets held for sale

     4,662        5,612   

Insurance subsidiary investments

     119,208        110,227   

Other

     207,471        198,469   
  

 

 

   

 

 

 

Total assets

   $ 4,242,530      $ 4,138,493   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Current liabilities:

    

Accounts payable

   $ 204,293      $ 216,801   

Salaries, wages and other compensation

     382,150        407,493   

Due to third party payors

     26,367        37,306   

Professional liability risks

     46,458        46,010   

Other accrued liabilities

     134,037        130,693   

Long-term debt due within one year

     9,611        10,620   
  

 

 

   

 

 

 
     802,916        848,923   

Long-term debt

     1,638,280        1,531,882   

Professional liability risks

     231,477        217,717   

Deferred tax liabilities

     7,557        17,955   

Deferred credits and other liabilities

     200,599        191,771   

Noncontrolling interests-redeemable

     9,373        9,704   

Commitments and contingencies

    

Equity:

    

Stockholders’ equity:

    

Common stock, $0.25 par value; authorized 175,000 shares; issued 52,965 shares—June 30, 2012 and 52,116 shares—December 31, 2011

     13,241        13,029   

Capital in excess of par value

     1,138,825        1,138,189   

Accumulated other comprehensive loss

     (1,445     (1,469

Retained earnings

     172,865        139,172   
  

 

 

   

 

 

 
     1,323,486        1,288,921   

Noncontrolling interests-nonredeemable

     28,842        31,620   
  

 

 

   

 

 

 

Total equity

     1,352,328        1,320,541   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 4,242,530      $ 4,138,493   
  

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

KINDRED HEALTHCARE, INC.

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

(In thousands)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Cash flows from operating activities:

        

Net income (loss)

   $ 15,263      $ (5,953   $ 33,905      $ 16,144   

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

        

Depreciation and amortization

     49,802        37,871        98,492        70,420   

Amortization of stock-based compensation costs

     3,077        3,462        4,879        6,106   

Amortization of deferred financing costs

     2,359        2,244        4,716        3,090   

Payment of lender fees related to debt issuance

     —          (46,232     —          (46,232

Provision for doubtful accounts

     6,041        8,426        13,537        14,256   

Deferred income taxes

     (13,243     (1,959     (16,905     (2,689

Impairment charges

     329        —          1,196        —     

Other

     1,919        (227     2,345        (703

Change in operating assets and liabilities:

        

Accounts receivable

     (23,891     (43,935     (81,088     (80,575

Inventories and other assets

     498        870        (15,407     (2,655

Accounts payable

     (2,983     13,565        (12,533     1,217   

Income taxes

     229        (12,950     30,731        27,673   

Due to third party payors

     (1,963     6,577        (10,939     3,555   

Other accrued liabilities

     15,586        43,093        (3,331     41,681   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     53,023        4,852        49,598        51,288   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

        

Routine capital expenditures

     (28,759     (33,950     (50,865     (58,668

Development capital expenditures

     (12,376     (14,309     (22,998     (25,418

Acquisitions, net of cash acquired

     (17,420     (651,952     (67,868     (659,979

Acquisition deposit

     16,866        —          —          —     

Sale of assets

     —          —          1,110        1,714   

Purchase of insurance subsidiary investments

     (7,425     (9,220     (21,198     (17,037

Sale of insurance subsidiary investments

     8,004        8,533        22,010        27,189   

Net change in insurance subsidiary cash and cash equivalents

     (1,363     (2,744     (14,486     (4,044

Change in other investments

     182        —          451        1,000   

Other

     (255     (161     (1,004     (29
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (42,546     (703,803     (154,848     (735,272
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

        

Proceeds from borrowings under revolving credit

     449,300        654,900        964,700        1,100,100   

Repayment of borrowings under revolving credit

     (457,500     (814,900     (854,500     (1,275,100

Proceeds from issuance of senior unsecured notes

     —          550,000        —          550,000   

Proceeds from issuance of term loan, net of discount

     —          693,000        —          693,000   

Repayment of other long-term debt

     (2,645     (345,666     (5,311     (345,688

Payment of deferred financing costs

     (270     (6,443     (313     (6,860

Contribution made by noncontrolling interest

     200        —          200        —     

Cash distributed to noncontrolling interests

     (2,133     —          (3,521     —     

Issuance of common stock

     —          1,604        —          3,019   

Other

     —          355        —          744   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (13,048     732,850        101,255        719,215   
  

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

     (2,571     33,899        (3,995     35,231   

Cash and cash equivalents at beginning of period

     40,137        18,500        41,561        17,168   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 37,566      $ 52,399      $ 37,566      $ 52,399   
  

 

 

   

 

 

   

 

 

   

 

 

 

Supplemental information:

        

Interest payments

   $ 35,526      $ 4,056      $ 47,634      $ 6,944   

Income tax payments (refunds)

     23,802        11,503        9,846        (13,283

Issuance of common stock in RehabCare acquisition

     —          300,426        —          300,426   

Financing costs paid in connection with RehabCare acquisition

     —          13,074        —          13,074   

See accompanying notes.

 

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Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—BASIS OF PRESENTATION

Business

Kindred Healthcare, Inc. is a healthcare services company that through its subsidiaries operates long-term acute care (“LTAC”) hospitals, inpatient rehabilitation hospitals (“IRFs”), nursing and rehabilitation centers, assisted living facilities, a contract rehabilitation services business and a home health and hospice business across the United States (collectively, the “Company” or “Kindred”). At June 30, 2012, the Company’s hospital division operated 118 LTAC hospitals and six IRFs in 26 states. The Company’s nursing center division operated 224 nursing and rehabilitation centers and six assisted living facilities in 27 states. The Company’s rehabilitation division provided rehabilitation services primarily in hospitals and long-term care settings. The Company’s home health and hospice division provided home health, hospice and private duty services from 52 locations in eight states.

In recent years, the Company has completed several transactions related to the divestiture of unprofitable hospitals and nursing and rehabilitation centers to improve its future operating results. For accounting purposes, the operating results of these businesses have been classified as discontinued operations in the accompanying unaudited condensed consolidated statement of operations for all periods presented. Assets not sold at June 30, 2012 have been measured at the lower of carrying value or estimated fair value less costs of disposal and have been classified as held for sale in the accompanying unaudited condensed consolidated balance sheet. See Note 4 for a summary of discontinued operations.

Recently issued accounting requirements

In September 2011, the Financial Accounting Standards Board (the “FASB”) issued authoritative guidance related to testing goodwill for impairment. The main provisions of the guidance state that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step goodwill impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform Step 1 of the goodwill impairment test. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance is not expected to have a material impact on the Company’s business, financial position, results of operations or liquidity.

In July 2011, the FASB issued authoritative guidance related to the presentation and disclosure of patient service revenue, provision for bad debts, and the allowance for doubtful accounts for certain healthcare entities. The provisions of the guidance require healthcare entities that recognize significant amounts of patient service revenue at the time services are rendered, even though they do not assess a patient’s ability to pay, to present the provision for bad debts related to those revenues as a deduction from patient service revenue (net of contractual allowances and discounts), as opposed to an operating expense. All other entities would continue to present the provision for bad debts as an operating expense. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have an impact on the Company’s business, financial position, results of operations or liquidity.

In June 2011, the FASB issued authoritative guidance related to the presentation of other comprehensive income. The provisions of the guidance state that an entity has the option to present the total of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The statement(s) should be presented with equal prominence to the other primary financial statements.

 

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Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 1—BASIS OF PRESENTATION (Continued)

Recently issued accounting requirements (Continued)

 

The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s business, financial position, results of operations or liquidity.

In December 2011, the FASB amended its authoritative guidance issued in June 2011 related to the presentation of other comprehensive income. The provisions indefinitely defer the requirement to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented, for both interim and annual financial statements. All other requirements of the June 2011 update were not impacted by the amendment which remains effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s business, financial position, results of operations or liquidity.

In May 2011, the FASB issued authoritative guidance related to fair value measurements. The provisions of the guidance result in applying common fair value measurement and disclosure requirements in both United States generally accepted accounting principles and International Financial Reporting Standards. The amendments primarily change the wording used to describe many of the requirements in generally accepted accounting principles for measuring and disclosing information about fair value measurements. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s business, financial position, results of operations or liquidity.

Indefinite-lived assets

In accordance with the authoritative guidance for goodwill and other intangible assets, the Company is required to perform an impairment test for indefinite-lived intangible assets at least annually or more frequently if adverse events or changes in circumstances indicate that the asset may be impaired.

The Company’s indefinite-lived intangible assets consist of trade names, Medicare certifications and certificates of need. The fair values of the Company’s indefinite-lived intangible assets are derived from current market data and projections at a facility level which include management’s best estimates of economic and market conditions over the projected period including growth rates in the number of admissions, patient days, reimbursement rates, operating costs, rent expense and capital expenditures. Other significant estimates and assumptions include terminal value growth rates, changes in working capital requirements and weighted average cost of capital. Certificates of need intangible assets are estimated primarily using both a replacement cost methodology and an excess earnings method, a form of discounted cash flows, which is based upon the concept that net after-tax cash flows provide a return supporting all of the assets of a business enterprise.

As a result of the RehabCare Merger (as defined in Note 2 below), the Company acquired indefinite-lived intangible assets consisting of trade names ($115.4 million), Medicare certifications ($75.9 million) and certificates of need ($7.9 million). The annual impairment test for these indefinite-lived intangible assets was performed as of May 1, 2012. No impairment charges were recorded in connection with this annual impairment test.

 

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Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 1—BASIS OF PRESENTATION (Continued)

 

Equity

The following table sets forth the changes in equity attributable to noncontrolling interests and equity attributable to Kindred stockholders for the six months ended June 30, 2012 and 2011 (in thousands):

 

      Redeemable
noncontrolling
interests
          Amounts
attributable to
Kindred
stockholders
    Nonredeemable
noncontrolling
interests
    Total
equity
 

For the six months ended June 30, 2012:

             

Balance at December 31, 2011

   $ 9,704           $ 1,288,921      $ 31,620      $ 1,320,541   

Comprehensive income (loss):

             

Net income (loss)

     240             33,693        (28     33,665   

Other comprehensive income

     —               24        —          24   
  

 

 

        

 

 

   

 

 

   

 

 

 
     240             33,717        (28     33,689   

Shares tendered by employees for statutory tax withholdings upon issuance of common stock

     —               (1,821     —          (1,821

Income tax provision in connection with the issuance of common stock under employee benefit plans

     —               (2,210     —          (2,210

Stock-based compensation amortization

     —               4,879        —          4,879   

Contribution made by noncontrolling interest

     —               —          200        200   

Distributions to noncontrolling interests

     (571          —          (2,950     (2,950
  

 

 

        

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

   $ 9,373           $ 1,323,486      $ 28,842      $ 1,352,328   
  

 

 

        

 

 

   

 

 

   

 

 

 
 

For the six months ended June 30, 2011:

             

Balance at December 31, 2010

   $ —             $ 1,031,759      $ —        $ 1,031,759   

Acquired noncontrolling interests

     23,869             —          23,990        23,990   

Comprehensive income (loss):

             

Net income (loss)

     (28          16,565        (393     16,172   

Other comprehensive income

     —               182        —          182   
  

 

 

        

 

 

   

 

 

   

 

 

 
     (28          16,747        (393     16,354   

Issuance of common stock in connection with employee benefit plans

     —               3,019        —          3,019   

Shares tendered by employees for statutory tax withholdings upon issuance of common stock

     —               (3,353     —          (3,353

Income tax benefit in connection with the issuance of common stock under employee benefit plans

     —               608        —          608   

Stock-based compensation amortization

     —               6,106        —          6,106   

Equity consideration for RehabCare Merger (see Note 2)

     —               300,426        —          300,426   
  

 

 

        

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

   $ 23,841           $ 1,355,312      $ 23,597      $ 1,378,909   
  

 

 

        

 

 

   

 

 

   

 

 

 

Derivative financial instruments

In December 2011, the Company entered into two interest rate swap agreements to hedge its floating interest rate on an aggregate of $225.0 million of outstanding Term Loan Facility (as defined in Note 2 below) debt. The interest rate swaps have an effective date of January 9, 2012, and expire on January 11, 2016. The Company is required to make payments based upon a fixed interest rate of 1.8925% calculated on the notional amount of $225.0 million. In exchange, the Company will receive interest on $225.0 million at a variable interest rate that is based upon the three-month London Interbank Offered Rate (“LIBOR”), subject to a minimum rate of 1.5%. The Company determined the interest rate swaps continue to be effective cash flow hedges at June 30, 2012. The fair value of the interest rate swaps recorded in other accrued liabilities was $2.1 million and $0.8 million at June 30, 2012 and December 31, 2011, respectively.

 

9


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 1—BASIS OF PRESENTATION (Continued)

 

Other information

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q of Regulation S-X and do not include all of the disclosures normally required by generally accepted accounting principles or those normally required in annual reports on Form 10-K. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended December 31, 2011 filed with the Securities and Exchange Commission (the “SEC”) on Form 10-K. The accompanying condensed consolidated balance sheet at December 31, 2011 was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the Company’s customary accounting practices. Management believes that financial information included herein reflects all adjustments necessary for a fair presentation of interim results and, except as otherwise disclosed, all such adjustments are of a normal and recurring nature.

The accompanying unaudited condensed 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 those estimates.

Reclassifications

Certain prior period amounts have been reclassified to conform with the current period presentation.

NOTE 2—REHABCARE ACQUISITION

On June 1, 2011, the Company completed the acquisition of RehabCare Group, Inc. and its subsidiaries (“RehabCare”) (the “RehabCare Merger”). Upon consummation of the RehabCare Merger, each issued and outstanding share of RehabCare common stock was converted into the right to receive 0.471 of a share of Kindred common stock and $26 per share in cash, without interest (the “Merger Consideration”). Kindred issued approximately 12 million shares of its common stock in connection with the RehabCare Merger. The purchase price totaled $962.8 million and was comprised of $662.4 million in cash and $300.4 million of Kindred common stock at fair value. The Company also assumed $355.7 million of long-term debt in the RehabCare Merger, of which $345.4 million was refinanced on June 1, 2011. The operating results of RehabCare have been included in the accompanying unaudited condensed consolidated financial statements of the Company since June 1, 2011.

At the RehabCare Merger date, the Company acquired 32 LTAC hospitals, five IRFs, approximately 1,200 rehabilitation therapy sites of service and 102 hospital-based inpatient rehabilitation units.

Operating results in the second quarter of 2011 included transaction costs totaling $19.1 million, financing costs totaling $11.8 million and severance costs totaling $14.9 million related to the RehabCare Merger. Operating results for the six months ended June 30, 2011 included transaction costs totaling $23.0 million, financing costs totaling $13.8 million and severance costs totaling $14.9 million related to the RehabCare Merger. In the accompanying unaudited condensed consolidated statement of operations, transaction costs were included in other operating expenses, financing costs were included in interest expense and severance costs were included in salaries, wages and benefits.

 

10


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 2—REHABCARE ACQUISITION (Continued)

 

In connection with the RehabCare Merger, the Company entered into a new $650 million senior secured asset-based revolving credit facility (the “ABL Facility”) and a new $700 million senior secured term loan facility (the “Term Loan Facility”) (collectively, the “New Credit Facilities”). The Company also successfully completed the private placement of $550 million of senior notes due 2019 (the “Notes”). The Company used proceeds from the New Credit Facilities and the Notes to pay the Merger Consideration, repay all amounts outstanding under the Company’s and RehabCare’s previous credit facilities and to pay transaction costs. The amounts outstanding under the Company’s and RehabCare’s former credit facilities that were repaid at the RehabCare Merger closing were $390.0 million and $345.4 million, respectively. The New Credit Facilities have incremental facility capacity in an aggregate amount between the two facilities of $200 million, subject to meeting certain conditions, including a specified senior secured leverage ratio with respect to the Term Loan Facility. In connection with these new credit arrangements, the Company paid $46.2 million of lender fees related to debt issuance that were capitalized as deferred financing costs and paid $13.1 million of other financing costs that were charged to interest expense during 2011.

Pro forma information

The unaudited pro forma net effect of the RehabCare Merger assuming the acquisition occurred as of January 1, 2010 is as follows (in thousands, except per share amounts):

 

     Three months
ended
June 30,
2011
     Six months
ended
June 30,
2011
 

Revenues

   $ 1,533,515       $ 3,090,535   

Income from continuing operations attributable to Kindred

     25,501         62,027   

Income attributable to Kindred

     26,163         65,478   

Earnings per common share:

     

Basic:

     

Income from continuing operations

   $ 0.49       $ 1.19   

Net income

   $ 0.50       $ 1.26   

Diluted:

     

Income from continuing operations

   $ 0.49       $ 1.18   

Net income

   $ 0.50       $ 1.25   

The unaudited pro forma financial data has been derived by combining the historical financial results of the Company and the operations acquired in the RehabCare Merger for the period presented. The unaudited pro forma financial data includes transaction, financing and severance costs totaling $74.5 million incurred by both the Company and RehabCare in connection with the RehabCare Merger. These costs have been eliminated from the results of operations for 2011 and were reflected as expenses incurred as of January 1, 2010 for purposes of the pro forma financial presentation. Revenues and earnings before interest, income taxes and transaction-related costs associated with RehabCare aggregated $359.2 million and $33.7 million, respectively, in the second quarter of 2012, aggregated $723.7 million and $65.3 million, respectively, for the six months ended June 30, 2012 and aggregated $113.7 million and $9.0 million, respectively, in the second quarter of 2011.

NOTE 3—OTHER ACQUISITIONS

The following is a summary of the Company’s other significant acquisition activities. The purchase price of the acquired leased facilities resulted from negotiations with each of the sellers that were based upon both the historical and expected future cash flows of the respective facilities and real estate values. Each of these acquisitions was financed through operating cash flows or borrowings under the Company’s revolving credit facility.

 

11


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 3—OTHER ACQUISITIONS (Continued)

 

During the six months ended June 30, 2012, the Company acquired the real estate of two previously leased hospitals for $67.9 million. Annual rent associated with the hospitals aggregated $5.5 million. During the six months ended June 30, 2011, the Company acquired the real estate of a previously leased hospital for $8.0 million. Annual rent associated with the hospital aggregated $0.9 million.

In April 2011, the Company acquired a home health company for $9.5 million, which included $0.1 million of property and equipment, $7.5 million of goodwill and $1.9 million of identifiable intangible assets.

The fair value of each of the acquisitions noted above was measured using discounted cash flow methodologies which are considered Level 3 inputs (as described in Note 12).

NOTE 4—DISCONTINUED OPERATIONS

In accordance with the authoritative guidance for the impairment or disposal of long-lived assets, the divestitures of unprofitable businesses discussed in Note 1 have been accounted for as discontinued operations. Accordingly, the results of operations of these businesses for all periods presented have been classified as discontinued operations, net of income taxes, in the accompanying unaudited condensed consolidated statement of operations. At June 30, 2012, the Company held for sale two hospitals.

A summary of discontinued operations follows (in thousands):

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Revenues

   $ 254      $ 208      $ 334      $ 177   
  

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

     (94     (160     (192     (316

Supplies

     3        (1     3        (3

Rent

     29        29        59        58   

Other operating expenses (income)

     339        (615     307        (225

Depreciation

     —          —          —          —     

Interest expense

     —          —          —          —     

Investment income

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 
     277        (747     177        (486
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations before income taxes

     (23     955        157        663   

Provision (benefit) for income taxes

     (9     368        61        255   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

   $ (14   $ 587      $ 96      $ 408   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

12


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 4—DISCONTINUED OPERATIONS (Continued)

 

The following table sets forth certain discontinued operating data by business segment (in thousands):

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Revenues:

        

Hospital division

   $ 183      $ 11      $ 201      $ (24

Nursing center division

     71        197        133        201   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $       254      $       208      $       334      $       177   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss):

        

Hospital division

   $ (68   $ (282   $ (371   $ (698

Nursing center division

     74        1,266        587        1,419   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 6      $ 984      $ 216      $ 721   
  

 

 

   

 

 

   

 

 

   

 

 

 

Rent:

        

Hospital division

   $ 29      $ 29      $ 58      $ 58   

Nursing center division

     —          —          1        —     
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 29      $ 29      $ 59      $ 58   
  

 

 

   

 

 

   

 

 

   

 

 

 

A summary of the net assets held for sale follows (in thousands):

 

     June 30,
2012
     December 31,
2011
 

Long-term assets:

     

Property and equipment, net

   $       4,662       $       5,607   

Other

     —           5   
  

 

 

    

 

 

 
     4,662         5,612   

Current liabilities (included in other accrued liabilities)

     —           (118
  

 

 

    

 

 

 
   $ 4,662       $ 5,494   
  

 

 

    

 

 

 

NOTE 5—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, Medicare Advantage and other third party payors.

A summary of revenues by payor type follows (in thousands):

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Medicare

   $ 642,058      $ 576,778      $ 1,320,982      $ 1,132,568   

Medicaid

     265,184        262,450        529,422        522,129   

Medicare Advantage

     118,566        98,074        236,979        193,455   

Other

     596,693        434,687        1,203,512        795,429   
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,622,501        1,371,989        3,290,895        2,643,581   

Eliminations

     (86,673     (79,397     (175,097     (158,568
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 1,535,828      $ 1,292,592      $ 3,115,798      $ 2,485,013   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

13


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 6—EARNINGS (LOSS) PER SHARE

Earnings (loss) 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 includes the dilutive effect of stock options. The Company follows the provisions of the authoritative guidance for determining whether instruments granted in share-based payment transactions are participating securities, which requires that unvested restricted stock that entitles the holder to receive nonforfeitable dividends before vesting be included as a participating security in the basic and diluted earnings per common share calculation pursuant to the two-class method.

A computation of earnings (loss) per common share follows (in thousands, except per share amounts):

 

     Three months ended June 30,     Six months ended June 30,  
     2012     2011     2012     2011  
     Basic     Diluted     Basic     Diluted     Basic     Diluted     Basic     Diluted  

Earnings (loss):

                

Amounts attributable to Kindred stockholders:

                

Income (loss) from continuing operations:

                

As reported in Statement of Operations

   $ 15,516      $ 15,516      $ (6,119   $ (6,119   $ 33,597      $ 33,597      $ 16,157      $ 16,157   

Allocation to participating unvested restricted stockholders

     (372     (371     —          —          (633     (633     (296     (292
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Available to common stockholders

   $ 15,144      $ 15,145      $ (6,119   $ (6,119   $ 32,964      $ 32,964      $ 15,861      $ 15,865   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations:

                

As reported in Statement of Operations

   $ (14   $ (14   $ 587      $ 587      $ 96      $ 96      $ 408      $ 408   

Allocation to participating unvested restricted stockholders

     —          —          —          —          (2     (2     (7     (7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Available to common stockholders

   $ (14   $ (14   $ 587      $ 587      $ 94      $ 94      $ 401      $ 401   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss):

                

As reported in Statement of Operations

   $ 15,502      $ 15,502      $ (5,532   $ (5,532   $ 33,693      $ 33,693      $ 16,565      $ 16,565   

Allocation to participating unvested restricted stockholders

     (372     (371     —          —          (635     (635     (303     (299
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Available to common stockholders

   $ 15,130      $ 15,131      $ (5,532   $ (5,532   $ 33,058      $ 33,058      $ 16,262      $ 16,266   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in the computation:

                

Weighted average shares outstanding—basic computation

     51,664        51,664        43,231        43,231        51,633        51,633        41,145        41,145   
  

 

 

     

 

 

     

 

 

     

 

 

   

Dilutive effect of employee stock options

       11          —            24          516   
    

 

 

     

 

 

     

 

 

     

 

 

 

Adjusted weighted average shares outstanding—diluted computation

       51,675          43,231          51,657          41,661   
    

 

 

     

 

 

     

 

 

     

 

 

 

Earnings (loss) per common share:

                

Income (loss) from continuing operations

   $ 0.29      $ 0.29      $ (0.14   $ (0.14   $ 0.64      $ 0.64      $ 0.39      $ 0.38   

Income (loss) from discontinued operations

     —          —          0.01        0.01        —          —          0.01        0.01   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.29      $ 0.29      $ (0.13   $ (0.13   $ 0.64      $ 0.64      $ 0.40      $ 0.39   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Number of antidilutive stock options excluded from shares used in the diluted earnings (loss) per common share computation

       2,296          836          2,296          1,094   

 

14


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 7—BUSINESS SEGMENT DATA

The Company is organized into four operating divisions: the hospital division, the nursing center division, the rehabilitation division and the home health and hospice division. The expansion of the Company’s home health and hospice operations and changes to the Company’s organizational structure have led the Company to segregate its home health and hospice business into a separate division. The Company’s home health and hospice division was previously included in the rehabilitation division. Based upon the authoritative guidance for business segments and after giving consideration to the Company’s business segments after the RehabCare Merger, the operating divisions represent five reportable operating segments, including (1) hospitals, (2) skilled nursing and rehabilitation centers, (3) skilled nursing-based rehabilitation contract therapy services, (4) hospital-based rehabilitation contract therapy services and (5) home health and hospice services. These reportable operating segments are consistent with information used by the Company’s Chief Executive Officer and Chief Operating Officer to assess performance and allocate resources. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. Prior period segment information has been restated to conform with the current period presentation.

For segment purposes, the Company defines operating income as earnings before interest, income taxes, depreciation, amortization and rent. Operating income reported for each of the Company’s operating segments excludes impairment charges, transaction costs and the allocation of corporate overhead.

Operating income for the hospital division in the second quarter of 2012 included severance ($0.6 million) and other miscellaneous costs ($2.0 million) incurred in connection with the closing of two LTAC hospitals and the cancellation of a sub-acute unit project, and $5.0 million for employment-related lawsuits. Operating income for the hospital division for the six months ended June 30, 2012 included severance ($2.6 million) and other miscellaneous costs ($2.3 million) incurred in connection with the closing of a regional office and three LTAC hospitals and the cancellation of a sub-acute unit project, and $5.0 million for employment-related lawsuits.

Operating income for the nursing center division in the second quarter of 2012 and for the six months ended June 30, 2012 included employee retention costs of $0.7 million incurred in connection with the decision to allow leases to expire for 54 nursing and rehabilitation centers leased from Ventas, Inc. (“Ventas”).

Rent expense for the hospital division included $1.1 million and $2.9 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, incurred in connection with the closing of three LTAC hospitals.

 

15


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 7—BUSINESS SEGMENT DATA (Continued)

 

The following table sets forth certain data by business segment (in thousands):

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Revenues:

        

Hospital division

   $ 729,419      $ 593,425      $ 1,495,242      $ 1,152,399   

Nursing center division

     535,644        568,199        1,079,963        1,135,671   

Rehabilitation division:

        

Skilled nursing rehabilitation services

     255,187        161,246        510,638        275,864   

Hospital rehabilitation services

     73,379        38,291        147,748        60,781   
  

 

 

   

 

 

   

 

 

   

 

 

 
     328,566        199,537        658,386        336,645   

Home health and hospice division

     28,872        10,828        57,304        18,866   
  

 

 

   

 

 

   

 

 

   

 

 

 
     1,622,501        1,371,989        3,290,895        2,643,581   

Eliminations:

        

Skilled nursing rehabilitation services

     (57,056     (57,587     (115,489     (114,668

Hospital rehabilitation services

     (27,755     (20,706     (56,072     (41,931

Nursing and rehabilitation centers

     (1,862     (1,104     (3,536     (1,969
  

 

 

   

 

 

   

 

 

   

 

 

 
     (86,673     (79,397     (175,097     (158,568
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 1,535,828      $ 1,292,592      $ 3,115,798      $ 2,485,013   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations:

        

Operating income (loss):

        

Hospital division

   $ 141,511      $ 108,465      $ 302,180      $ 216,850   

Nursing center division

     71,005        93,532        136,538        180,882   

Rehabilitation division:

        

Skilled nursing rehabilitation services

     22,942        15,978        37,135        25,137   

Hospital rehabilitation services

     17,860        8,033        33,976        13,365   
  

 

 

   

 

 

   

 

 

   

 

 

 
     40,802        24,011        71,111        38,502   

Home health and hospice division

     2,789        (447     5,130        (457

Corporate:

        

Overhead

     (44,723     (43,801     (87,451     (82,116

Insurance subsidiary

     (600     (420     (1,082     (1,022
  

 

 

   

 

 

   

 

 

   

 

 

 
     (45,323     (44,221     (88,533     (83,138

Impairment charges

     (329     —          (1,196     —     

Transaction costs

     (597     (34,851     (1,082     (39,030
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     209,858        146,489        424,148        313,609   

Rent

     (107,541     (95,677     (215,509     (187,130

Depreciation and amortization

     (49,802     (37,871     (98,492     (70,420

Interest, net

     (26,441     (22,900     (52,727     (28,133
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     26,074        (9,959     57,420        27,926   

Provision (benefit) for income taxes

     10,797        (3,419     23,611        12,190   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 15,277      $ (6,540   $ 33,809      $ 15,736   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

16


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 7—BUSINESS SEGMENT DATA (Continued)

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Rent:

           

Hospital division

   $ 54,719       $ 43,997       $ 110,086       $ 84,296   

Nursing center division

     50,229         49,562         100,167         98,946   

Rehabilitation division:

           

Skilled nursing rehabilitation services

     1,359         1,540         2,751         3,049   

Hospital rehabilitation services

     39         33         117         61   
  

 

 

    

 

 

    

 

 

    

 

 

 
     1,398         1,573         2,868         3,110   

Home health and hospice division

     609         251         1,224         440   

Corporate

     586         294         1,164         338   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 107,541       $ 95,677       $ 215,509       $ 187,130   
  

 

 

    

 

 

    

 

 

    

 

 

 

Depreciation and amortization:

           

Hospital division

   $ 22,866       $ 16,572       $ 45,469       $ 30,850   

Nursing center division

     13,229         13,038         25,970         24,831   

Rehabilitation division:

           

Skilled nursing rehabilitation services

     2,724         1,221         5,352         1,875   

Hospital rehabilitation services

     2,323         819         4,647         916   
  

 

 

    

 

 

    

 

 

    

 

 

 
     5,047         2,040         9,999         2,791   

Home health and hospice division

     925         118         1,823         223   

Corporate

     7,735         6,103         15,231         11,725   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 49,802       $ 37,871       $ 98,492       $ 70,420   
  

 

 

    

 

 

    

 

 

    

 

 

 

Capital expenditures, excluding acquisitions (including discontinued operations):

           

Hospital division:

           

Routine

   $ 9,095       $ 11,809       $ 19,440       $ 23,953   

Development

     11,289         6,423         21,238         14,200   
  

 

 

    

 

 

    

 

 

    

 

 

 
     20,384         18,232         40,678         38,153   

Nursing center division:

           

Routine

     3,417         8,000         7,646         16,155   

Development

     1,087         7,705         1,760         11,027   
  

 

 

    

 

 

    

 

 

    

 

 

 
     4,504         15,705         9,406         27,182   

Rehabilitation division:

           

Skilled nursing rehabilitation services:

           

Routine

     569         179         895         414   

Development

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     569         179         895         414   

Hospital rehabilitation services:

           

Routine

     60         72         106         97   

Development

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     60         72         106         97   

Home health and hospice division:

           

Routine

     145         38         269         58   

Development

     —           181         —           191   
  

 

 

    

 

 

    

 

 

    

 

 

 
     145         219         269         249   

Corporate:

           

Information systems

     15,195         13,641         22,059         17,573   

Other

     278         211         450         418   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 41,135       $ 48,259       $ 73,863       $ 84,086   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

17


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 7—BUSINESS SEGMENT DATA (Continued)

 

     June 30,
2012
     December 31,
2011
 

Assets at end of period:

     

Hospital division

   $ 2,130,276       $ 2,056,103   

Nursing center division

     638,197         638,078   

Rehabilitation division:

     

Skilled nursing rehabilitation services

     452,726         425,499   

Hospital rehabilitation services

     343,185         347,491   
  

 

 

    

 

 

 
     795,911         772,990   

Home health and hospice division

     110,488         104,374   

Corporate

     567,658         566,948   
  

 

 

    

 

 

 
   $ 4,242,530       $ 4,138,493   
  

 

 

    

 

 

 

Goodwill:

     

Hospital division

   $ 747,777       $ 745,411   

Rehabilitation division:

     

Skilled nursing rehabilitation services

     107,899         107,026   

Hospital rehabilitation services

     168,019         167,753   
  

 

 

    

 

 

 
     275,918         274,779   

Home health and hospice division

     64,684         64,465   
  

 

 

    

 

 

 
   $ 1,088,379       $ 1,084,655   
  

 

 

    

 

 

 

NOTE 8—INSURANCE RISKS

The Company insures a substantial portion of its professional liability risks and workers compensation risks through its wholly owned limited purpose insurance subsidiary. Provisions for loss for these risks are based upon management’s best available information including 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 expected ultimate claims costs vary from historical provisions for loss, future earnings will be charged or credited.

The provision for loss for insurance risks, including the cost of coverage maintained with unaffiliated commercial insurance carriers, follows (in thousands):

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Professional liability:

        

Continuing operations

   $ 20,501      $ 16,871      $ 39,567      $ 34,631   

Discontinued operations

     73        (942     (244     (821

Workers compensation:

        

Continuing operations

   $ 15,677      $ 14,081      $ 30,795      $ 27,149   

Discontinued operations

     (141     (219     (288     (520

 

18


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 8—INSURANCE RISKS (Continued)

 

A summary of the assets and liabilities related to insurance risks included in the accompanying unaudited condensed consolidated balance sheet follows (in thousands):

 

     June 30, 2012      December 31, 2011  
     Professional
liability
     Workers
compensation
     Total      Professional
liability
     Workers
compensation
     Total  

Assets:

                 

Current:

                 

Insurance subsidiary investments

   $ 45,389       $ 30,533       $ 75,922       $ 44,678       $ 25,747       $ 70,425   

Reinsurance recoverables

     2,033         —           2,033         323         —           323   

Other

     —           150         150         —           150         150   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     47,422         30,683         78,105         45,001         25,897         70,898   

Non-current:

                 

Insurance subsidiary investments

     54,223         64,985         119,208         39,048         71,179         110,227   

Reinsurance and other recoverables

     49,943         71,366         121,309         44,356         64,704         109,060   

Deposits

     3,977         1,574         5,551         3,643         1,623         5,266   

Other

     —           41         41         —           42         42   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     108,143         137,966         246,109         87,047         137,548         224,595   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 155,565       $ 168,649       $ 324,214       $ 132,048       $ 163,445       $ 295,493   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

                 

Allowance for insurance risks:

                 

Current

   $ 46,458       $ 34,832       $ 81,290       $ 46,010       $ 32,198       $ 78,208   

Non-current

     231,477         147,079         378,556         217,717         138,489         356,206   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 277,935       $ 181,911       $ 459,846       $ 263,727       $ 170,687       $ 434,414   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Provisions for loss for professional liability risks retained by the Company’s limited purpose insurance subsidiary have been discounted based upon actuarial estimates of claim payment patterns using a discount rate of 1% to 5% depending upon the policy year. The discount rate was 1% for the 2012 and 2011 policy years. The discount rates are based upon the risk free interest rate for the respective year. 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. If the Company did not discount any of the allowances for professional liability risks, these balances would have approximated $280.6 million at June 30, 2012 and $266.5 million at December 31, 2011.

Provisions for loss for workers compensation risks retained by the Company’s limited purpose insurance subsidiary are not discounted and amounts equal to the loss provision are funded annually.

NOTE 9—INSURANCE SUBSIDIARY INVESTMENTS

The Company maintains investments, consisting principally of cash and cash equivalents, debt securities, equities and certificates of deposit for the payment of claims and expenses related to professional liability and workers compensation risks. These investments have been categorized as available-for-sale and are reported at fair value.

 

19


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 9—INSURANCE SUBSIDIARY INVESTMENTS (Continued)

 

The amortized cost and estimated fair value of the Company’s insurance subsidiary investments follows (in thousands):

 

    June 30, 2012     December 31, 2011  
    Amortized
cost
    Unrealized
gains
    Unrealized
losses
    Fair
value
    Amortized
cost
    Unrealized
gains
    Unrealized
losses
    Fair
value
 

Cash and cash equivalents (a)

  $ 133,363      $ —        $ —        $ 133,363      $ 118,877      $ —        $ —        $ 118,877   

Debt securities:

               

Corporate bonds

    21,454        118        (17     21,555        23,134        163        (48     23,249   

Debt securities issued by U.S. government agencies

    20,005        107        (1     20,111        18,173        120        (5     18,288   

U.S. Treasury notes

    2,607        4        —          2,611        3,867        10        —          3,877   

Debt securities issued by foreign governments

    624        4        —          628        625        8        —          633   

Commercial mortgage-backed securities

    —          —          —          —          137        6        —          143   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    44,690        233        (18     44,905        45,936        307        (53     46,190   

Equities by industry:

               

Consumer

    2,171        631        (41     2,761        2,171        329        (45     2,455   

Industrials

    2,039        351        (54     2,336        2,039        248        (111     2,176   

Technology

    1,482        282        (88     1,676        1,482        215        (99     1,598   

Healthcare

    1,474        99        (46     1,527        1,474        77        (72     1,479   

Financial services

    1,419        171        (154     1,436        1,419        89        (227     1,281   

Other

    2,554        558        (213     2,899        2,554        345        (209     2,690   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    11,139        2,092        (596     12,635        11,139        1,303        (763     11,679   

Certificates of deposit

    4,225        2        —          4,227        3,905        3        (2     3,906   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 193,417      $ 2,327      $ (614   $ 195,130      $ 179,857      $ 1,613      $ (818   $ 180,652   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Includes $3.6 million and $2.2 million of money market funds at June 30, 2012 and December 31, 2011, respectively.

The Company’s investment policy governing insurance subsidiary investments precludes the investment portfolio managers from selling any security at a loss without prior authorization from the Company. The investment managers also limit the exposure to any one issue, issuer or type of investment. The Company intends, and has the ability, to hold insurance subsidiary investments for a long duration without the necessity of selling securities to fund the underwriting needs of its insurance subsidiary. This ability to hold securities allows sufficient time for recovery of temporary declines in the market value of equity securities and the par value of debt securities as of their stated maturity date.

The Company considered the severity and duration of its unrealized losses at June 30, 2012 and 2011 for various investments held in its insurance subsidiary investment portfolio and determined that these unrealized losses were temporary and did not record any impairment losses related to these investments.

As a result of deterioration in professional liability and workers compensation underwriting results of the Company’s limited purpose insurance subsidiary in 2011, the Company made a capital contribution of $8.6 million during the six months ended June 30, 2012 to its limited purpose insurance subsidiary. Conversely, as a result of improved professional liability underwriting results of the Company’s limited purpose insurance subsidiary in 2010, the Company received a distribution of $3.5 million during the six months ended June 30, 2011 from its limited purpose insurance subsidiary. These transactions were completed in accordance with applicable regulations. Neither the contribution nor the distribution had any impact on earnings.

 

20


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 10—LEASES

On April 27, 2012, the Company provided Ventas with notices to renew the master lease agreements for 19 nursing and rehabilitation centers and six LTAC hospitals (collectively, the “Renewal Facilities”) for an additional five years. The current lease term for the Renewal Facilities is scheduled to expire in April 2013.

Under its master lease agreements with Ventas, the Company had 73 nursing and rehabilitation centers and 16 LTAC hospitals within ten separate renewal bundles subject to lease renewals. Each renewal bundle contains both nursing and rehabilitation centers and LTAC hospitals. The master lease agreements require that the Company renew all or none of the facilities within a renewal bundle.

The Company has renewed three renewal bundles containing the Renewal Facilities. The Renewal Facilities contain 2,178 licensed nursing and rehabilitation center beds and 616 licensed hospital beds and generated revenues of approximately $434 million for the year ended December 31, 2011. The current annual rent for the Renewal Facilities approximates $46 million.

The Company did not renew seven renewal bundles containing 54 nursing and rehabilitation centers and ten LTAC hospitals. These facilities contain 6,140 licensed nursing and rehabilitation center beds and 1,066 licensed hospital beds and generated revenues of approximately $790 million for the year ended December 31, 2011. The current annual rent for these facilities approximates $77 million.

On May 24, 2012, the Company entered into a new master lease agreement with Ventas for the ten LTAC hospitals that the Company had previously announced it did not intend to renew. The new master lease agreement will be effective on May 1, 2013 and will have a term of ten years with three five-year renewal options. The annual rent for the new lease will be $28 million and is subject to annual increases based on the increase in the consumer price index (subject to an annual 4% cap). The current annual rent for these ten LTAC hospitals approximates $22 million. These ten LTAC hospitals contain 1,066 licensed hospital beds and generated revenues of approximately $276 million for the year ended December 31, 2011. The terms of the new master lease agreement are substantially similar to the terms of the other master lease agreements between Kindred and Ventas.

On May 24, 2012, the Company and Ventas also entered into a separate agreement to provide Ventas with more flexibility to accelerate the transfer of the 54 nursing and rehabilitation centers currently leased by the Company that are scheduled to expire on April 30, 2013. The Company will continue to operate these nursing and rehabilitation centers and include them in its results from continuing operations through the expiration of the lease term in April 2013.

NOTE 11—CONTINGENCIES

Management continually evaluates contingencies based upon the best available information. In addition, allowances for losses are provided currently for disputed items that have continuing significance, such as certain third party reimbursements and deductions that continue to be claimed in current cost reports and tax returns.

Management believes that allowances for losses have been provided to the extent necessary and that its assessment of contingencies is reasonable.

Principal contingencies are described below:

Revenues—Certain third party payments are subject to examination by agencies administering the various reimbursement programs. The Company is contesting certain issues raised in audits of prior year cost reports.

Professional liability risks—The Company has provided for losses for professional liability risks based upon management’s best available information including actuarially determined estimates. Ultimate claims costs may differ from the provisions for loss. See Note 8.

 

21


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 11—CONTINGENCIES (Continued)

 

Income taxes—The Company is subject to various federal and state income tax audits in the ordinary course of business. Such audits could result in increased tax payments, interest and penalties.

Litigation—The Company is a party to various legal actions (some of which are not insured), and regulatory and other governmental audits and investigations in the ordinary course of business. The Company cannot predict the ultimate outcome of pending litigation and regulatory and other governmental audits and investigations. These matters could potentially subject the Company to sanctions, damages, recoupments, fines and other penalties. The U.S. Department of Justice (the “DOJ”), the Centers for Medicare and Medicaid Services (“CMS”) or other federal and state enforcement and regulatory agencies may conduct additional investigations related to the Company’s businesses in the future which may, either individually or in the aggregate, have a material adverse effect on the Company’s business, financial position, results of operations and liquidity. See Note 14.

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 related to 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 are initiated by a breach of the terms of a contract or by a third party claim or event.

NOTE 12—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

The Company follows the provisions of the authoritative guidance for fair value measurements, which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance related to fair value measures establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:

 

Level 1    Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as certain U.S. Treasury, other U.S. Government and agency asset backed debt securities that are highly liquid and are actively traded in over-the-counter markets.
Level 2    Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3    Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

22


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 12—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS (Continued)

 

The Company’s assets and liabilities measured at fair value on a recurring and non-recurring basis and any associated losses are summarized below (in thousands):

 

    Fair value measurements     Assets/liabilities
at fair value
    Total
losses
 
    Level 1     Level 2     Level 3      

June 30, 2012:

         

Recurring:

         

Assets:

         

Available-for-sale debt securities:

         

Corporate bonds

  $ —        $ 21,555      $ —        $ 21,555      $ —     

Debt securities issued by U.S. government agencies

    —          20,111        —          20,111        —     

U.S. Treasury notes

    2,611        —          —          2,611        —     

Debt securities issued by foreign governments

    —          628        —          628        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    2,611        42,294        —          44,905        —     

Available-for-sale equity securities

    12,635        —          —          12,635        —     

Money market funds

    7,226        —          —          7,226        —     

Certificates of deposit

    —          4,227        —          4,227        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale investments

    22,472        46,521        —          68,993        —     

Deposits held in money market funds

    5,248        3,977        —          9,225        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 27,720      $ 50,498      $ —        $ 78,218      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

         

Interest rate swaps

  $ —        $ (2,078   $ —        $ (2,078   $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-recurring:

         

Assets:

         

Property and equipment

  $ —        $ —        $ 132      $ 132      $ (1,196
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

  $ —        $ —        $ —        $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011:

         

Recurring:

         

Assets:

         

Available-for-sale debt securities:

         

Corporate bonds

  $ —        $ 23,249      $ —        $ 23,249      $ —     

Debt securities issued by U.S. government agencies

    —          18,288        —          18,288        —     

U.S. Treasury notes

    3,877        —          —          3,877        —     

Debt securities issued by foreign governments

    —          633        —          633        —     

Commercial mortgage-backed securities

    —          143        —          143        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    3,877        42,313        —          46,190        —     

Available-for-sale equity securities

    11,679        —          —          11,679        —     

Money market funds

    6,263        —          —          6,263        —     

Certificates of deposit

    —          3,906        —          3,906        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale investments

    21,819        46,219        —          68,038        —     

Deposits held in money market funds

    353        3,643        —          3,996        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 22,172      $ 49,862      $ —        $ 72,034      $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

         

Interest rate swaps

  $ —        $ (815   $ —        $ (815   $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-recurring:

         

Assets:

         

Hospital available for sale

  $ —        $ —        $ 1,200      $ 1,200      $ (1,490

Property and equipment

    —          —          6,604        6,604        (22,836

Goodwill—nursing and rehabilitation centers

    —          —          —          —          (6,080

Goodwill—skilled nursing rehabilitation services

    —          —          107,026        107,026        (45,999

Intangible assets—certificates of need

    —          —          1,000        1,000        (54,366
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ —        $ —        $ 115,830      $ 115,830      $ (130,771
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities

  $ —        $ —        $ —        $ —        $ —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

23


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 12—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS (Continued)

 

Recurring measurements

The Company’s available-for-sale investments held by its limited purpose insurance subsidiary consist of debt securities, equities, money market funds and certificates of deposit. These available-for-sale investments and the insurance subsidiary’s cash and cash equivalents of $129.8 million as of June 30, 2012 and $116.7 million as of December 31, 2011, classified as insurance subsidiary investments, are maintained for the payment of claims and expenses related to professional liability and workers compensation risks.

The Company also has available-for-sale investments totaling $3.6 million related to a deferred compensation plan that is maintained for certain of the Company’s current and former employees.

The fair value of actively traded debt and equity securities and money market funds are based upon quoted market prices and are generally classified as Level 1. The fair value of inactively traded debt securities and certificates of deposit are based upon either quoted market prices of similar securities or observable inputs such as interest rates using either a market or income valuation approach and are generally classified as Level 2. The Company’s investment advisors obtain and review pricing for each security. The Company is responsible for the determination of fair value and as such the Company reviews the pricing information from its advisors in determining reasonable estimates of fair value. Based upon the Company’s internal review procedures, there were no adjustments to the prices during the three or six months ended June 30, 2012 or June 30, 2011.

The Company’s deposits held in money market funds consist primarily of cash and cash equivalents held for general corporate purposes.

The fair value of the derivative liability associated with the interest rate swaps is estimated using industry-standard valuation models, which are Level 2 measurements. Such models project future cash flows and discount the future amounts to a present value using market-based observable inputs, including interest rate curves.

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments. The carrying value is equal to fair value for financial instruments that are based upon quoted market prices or current market rates. The Company’s long-term debt is based upon Level 2 inputs.

 

     June 30, 2012      December 31, 2011  

(In thousands)

   Carrying
value
     Fair
value
     Carrying
value
     Fair
value
 

Cash and cash equivalents

   $ 37,566       $ 37,566       $ 41,561       $ 41,561   

Cash–restricted

     5,422         5,422         5,551         5,551   

Insurance subsidiary investments

     195,130         195,130         180,652         180,652   

Tax refund escrow investments

     207         207         211         211   

Long-term debt, including amounts due within one year (excluding capital lease obligations totaling $2.3 million and $3.9 million at June 30, 2012 and December 31, 2011, respectively)

     1,645,594         1,586,787         1,538,557         1,406,751   

Non-recurring measurements

On July 29, 2011, CMS issued final rules which, among other things, significantly reduced Medicare payments to nursing centers and changed the reimbursement for the provision of group rehabilitation therapy services to Medicare beneficiaries beginning October 1, 2011 (the “2011 CMS Rules”). In connection with the preparation of the Company’s operating results for the third quarter of 2011, the Company determined that the

 

24


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 12—FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS (Continued)

Non-recurring measurements (Continued)

 

impact of the 2011 CMS Rules was a triggering event in the third quarter of 2011 and accordingly tested the recoverability of its nursing and rehabilitation centers reporting unit goodwill, intangible assets and property and equipment asset groups impacted by the reduced Medicare payments. The Company recorded pretax impairment charges aggregating $0.3 million and $1.2 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, for necessary property and equipment expenditures in impaired nursing and rehabilitation center asset groups. These charges reflected the amount by which the carrying value of certain assets exceeded their estimated fair value. The fair value of property and equipment was measured using Level 3 inputs such as replacement costs factoring in depreciation, economic obsolesce and inflation trends.

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION

The accompanying unaudited condensed consolidating financial information has been prepared and presented pursuant to SEC Regulation S-X, Rule 3-10, “Financial Statements of Guarantors and Issuers of Guaranteed Securities Registered or Being Registered.” The Company’s Notes issued on June 1, 2011 are fully and unconditionally guaranteed, subject to certain customary release provisions, by substantially all of the Company’s domestic 100% owned subsidiaries. The equity method has been used with respect to the parent company’s investment in subsidiaries.

 

25


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

 

The following unaudited condensed consolidating financial data presents the financial position of the parent company/issuer, the guarantor subsidiaries and the non-guarantor subsidiaries as of June 30, 2012 and December 31, 2011, and the respective results of operations and cash flows for the three and six months ended June 30, 2012 and June 30, 2011.

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)

 

     Three months ended June 30, 2012  

(In thousands)

   Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Revenues

   $ —        $ 1,444,958      $ 115,981      $ (25,111   $ 1,535,828   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

     1        866,151        40,954        —          907,106   

Supplies

     —          99,096        9,142        —          108,238   

Rent

     —          100,050        7,491        —          107,541   

Other operating expenses

     —          289,986        48,120        (25,111     312,995   

Other income

     —          (2,698     —          —          (2,698

Impairment charges

     —          329        —          —          329   

Depreciation and amortization

     —          46,989        2,813        —          49,802   

Management fees

     —          (3,029     3,029        —          —     

Intercompany interest (income) expense from affiliates

     (28,340     25,120        3,220        —          —     

Interest expense (income)

     26,568        (4,878     5,026        —          26,716   

Investment income

     —          (65     (210     —          (275

Equity in net income of consolidating affiliates

     (14,027     —          —          14,027        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (15,798     1,417,051        119,585        (11,084     1,509,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     15,798        27,907        (3,604     (14,027     26,074   

Provision for income taxes

     296        10,273        228        —          10,797   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     15,502        17,634        (3,832     (14,027     15,277   

Loss from discontinued operations, net of income taxes

     —          (14     —          —          (14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     15,502        17,620        (3,832     (14,027     15,263   

Loss attributable to noncontrolling interests

     —          —          239        —          239   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) attributable to Kindred

   $ 15,502      $ 17,620      $ (3,593   $ (14,027   $ 15,502   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 14,751      $ 17,620      $ (3,967   $ (13,892   $ 14,512   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) attributable to Kindred

   $ 14,751      $ 17,620      $ (3,728   $ (13,892   $ 14,751   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

 

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) (Continued)

 

     Three months ended June 30, 2011  

(In thousands)

   Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Revenues

   $ —        $ 1,263,130      $ 50,893      $ (21,431   $ 1,292,592   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

     145        751,748        13,240        —          765,133   

Supplies

     —          93,845        2,873        —          96,718   

Rent

     —          93,173        2,504        —          95,677   

Other operating expenses

     16        280,035        28,512        (21,431     287,132   

Other income

     —          (2,880     —          —          (2,880

Depreciation and amortization

     —          36,483        1,388        —          37,871   

Management fees

     —          (1,158     1,158        —          —     

Intercompany interest (income) expense from affiliates

     (25,464     24,134        1,330        —          —     

Interest expense (income)

     23,075        (8     90        —          23,157   

Investment (income) loss

     —          (1,569     1,312        —          (257

Equity in net loss of consolidating affiliates

     6,931        —          —          (6,931     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     4,703        1,273,803        52,407        (28,362     1,302,551   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

     (4,703     (10,673     (1,514     6,931        (9,959

Provision (benefit) for income taxes

     829        (4,310     62        —          (3,419
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations

     (5,532     (6,363     (1,576     6,931        (6,540

Income from discontinued operations, net of income taxes

     —          587        —          —          587   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (5,532     (5,776     (1,576     6,931        (5,953

Loss attributable to noncontrolling interests

     —          —          421        —          421   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loss attributable to Kindred

   $ (5,532   $ (5,776   $ (1,155   $ 6,931      $ (5,532
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (5,608   $ (5,776   $ (1,652   $ 7,007      $ (6,029
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss attributable to Kindred

   $ (5,608   $ (5,776   $ (1,231   $ 7,007      $ (5,608
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

27


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) (Continued)

 

    Six months ended June 30, 2012  

(In thousands)

  Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Revenues

  $ —        $ 2,923,192      $ 242,829      $ (50,223   $ 3,115,798   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

    70        1,767,564        84,774        —          1,852,408   

Supplies

    —          200,394        19,139        —          219,533   

Rent

    —          200,105        15,404        —          215,509   

Other operating expenses

    3        576,145        98,034        (50,223     623,959   

Other income

    —          (5,446     —          —          (5,446

Impairment charges

    —          1,196        —          —          1,196   

Depreciation and amortization

    —          92,298        6,194        —          98,492   

Management fees

    —          (6,377     6,377        —          —     

Intercompany interest (income) expense from affiliates

    (56,247     49,397        6,850        —          —     

Interest expense (income)

    52,861        (9,640     10,073        —          53,294   

Investment income

    —          (92     (475     —          (567

Equity in net income of consolidating affiliates

    (31,245     —          —          31,245        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    (34,558     2,865,544        246,370        (18,978     3,058,378   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    34,558        57,648        (3,541     (31,245     57,420   

Provision for income taxes

    865        22,411        335        —          23,611   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

    33,693        35,237        (3,876     (31,245     33,809   

Income from discontinued operations, net of income taxes

    —          96        —          —          96   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    33,693        35,333        (3,876     (31,245     33,905   

Earnings attributable to noncontrolling interests

    —          —          (212     —          (212
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) attributable to Kindred

  $ 33,693      $ 35,333      $ (4,088   $ (31,245   $ 33,693   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

  $ 33,717      $ 35,333      $ (3,279   $ (31,842   $ 33,929   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) attributable to Kindred

  $ 33,717      $ 35,333      $ (3,491   $ (31,842   $ 33,717   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

28


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

Condensed Consolidating Statement of Operations and Comprehensive Income (Loss) (Continued)

 

    Six months ended June 30, 2011  

(In thousands)

  Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Revenues

  $ —        $ 2,455,196      $ 72,178      $ (42,361   $ 2,485,013   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

    271        1,430,317        13,240        —          1,443,828   

Supplies

    —          183,867        2,873        —          186,740   

Rent

    3        184,623        2,504        —          187,130   

Other operating expenses

    47        538,770        50,045        (42,361     546,501   

Other income

    —          (5,665     —          —          (5,665

Depreciation and amortization

    —          69,032        1,388        —          70,420   

Management fees

    —          (1,158     1,158        —          —     

Intercompany interest (income) expense from affiliates

    (34,938     33,608        1,330        —          —     

Interest expense

    28,774        21        90        —          28,885   

Investment (income) loss

    —          (1,591     839        —          (752

Equity in net income of consolidating affiliates

    (12,943     —          —          12,943        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    (18,786     2,431,824        73,467        (29,418     2,457,087   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

    18,786        23,372        (1,289     (12,943     27,926   

Provision for income taxes

    2,221        9,815        154        —          12,190   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

    16,565        13,557        (1,443     (12,943     15,736   

Income from discontinued operations, net of income taxes

    —          408        —          —          408   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    16,565        13,965        (1,443     (12,943     16,144   

Loss attributable to noncontrolling interests

    —          —          421        —          421   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) attributable to Kindred

  $ 16,565      $ 13,965      $ (1,022   $ (12,943   $ 16,565   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

  $ 16,747      $ 13,965      $ (1,261   $ (13,125   $ 16,326   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) attributable to Kindred

  $ 16,747      $ 13,965      $ (840   $ (13,125   $ 16,747   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

29


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

 

Condensed Consolidating Balance Sheet

 

    As of June 30, 2012  

(In thousands)

  Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  
ASSETS          

Current assets:

         

Cash and cash equivalents

  $ —        $ 30,773      $ 6,793      $ —        $ 37,566   

Cash—restricted

    —          5,422        —          —          5,422   

Insurance subsidiary investments

    —          —          75,922        —          75,922   

Accounts receivable, net

    —          987,390        73,072        —          1,060,462   

Inventories

    —          28,439        2,809        —          31,248   

Deferred tax assets

    —          24,101        —          —          24,101   

Income taxes

    —          6,119        242        —          6,361   

Other

    —          34,095        1,343        —          35,438   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    —          1,116,339        160,181        —          1,276,520   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Property and equipment, net

    —          1,060,649        49,518        —          1,110,167   

Goodwill

    —          825,623        262,756        —          1,088,379   

Intangible assets, net

    —          413,448        22,675        —          436,123   

Assets held for sale

    —          4,662        —          —          4,662   

Insurance subsidiary investments

    —          —          119,208        —          119,208   

Investment in subsidiaries

    295,877        —          —          (295,877     —     

Intercompany

    2,621,450        —          —          (2,621,450     —     

Deferred tax assets

    805        —          12,065        (12,870     —     

Other

    48,230        97,678        61,563        —          207,471   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 2,966,362      $ 3,518,399      $ 687,966      $ (2,930,197   $ 4,242,530   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
LIABILITIES AND EQUITY          

Current liabilities:

         

Accounts payable

  $ —        $ 190,035      $ 14,258      $ —        $ 204,293   

Salaries, wages and other compensation

    15        341,023        41,112        —          382,150   

Due to third party payors

    —          26,367        —          —          26,367   

Professional liability risks

    —          3,478        42,980        —          46,458   

Other accrued liabilities

    2,078        125,260        6,699        —          134,037   

Long-term debt due within one year

    7,000        100        2,511        —          9,611   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    9,093        686,263        107,560        —          802,916   

Long-term debt

    1,633,783        410        4,087        —          1,638,280   

Intercompany

    —          2,305,409        316,041        (2,621,450     —     

Professional liability risks

    —          113,162        118,315        —          231,477   

Deferred tax liabilities

    —          20,427        —          (12,870     7,557   

Deferred credits and other liabilities

    —          138,496        62,103        —          200,599   

Noncontrolling interests-redeemable

    —          —          9,373        —          9,373   

Commitments and contingencies

         

Equity:

         

Stockholders’ equity

    1,323,486        254,232        41,645        (295,877     1,323,486   

Noncontrolling interests-nonredeemable

    —          —          28,842        —          28,842   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    1,323,486        254,232        70,487        (295,877     1,352,328   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 2,966,362      $ 3,518,399      $ 687,966      $ (2,930,197   $ 4,242,530   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

30


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

Condensed Consolidating Balance Sheet (Continued)

 

    As of December 31, 2011  

(In thousands)

  Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  
ASSETS          

Current assets:

         

Cash and cash equivalents

  $ —        $ 21,825      $ 19,736      $ —        $ 41,561   

Cash—restricted

    —          5,551        —          —          5,551   

Insurance subsidiary investments

    —          —          70,425        —          70,425   

Accounts receivable, net

    —          908,100        86,600        —          994,700   

Inventories

    —          28,220        2,840        —          31,060   

Deferred tax assets

    —          17,785        —          —          17,785   

Income taxes

    —          39,184        329        —          39,513   

Other

    —          30,489        2,198        —          32,687   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    —          1,051,154        182,128        —          1,233,282   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Property and equipment, net

    —          1,007,187        51,854        —          1,059,041   

Goodwill

    —          815,787        268,868        —          1,084,655   

Intangible assets, net

    —          420,468        26,739        —          447,207   

Assets held for sale

    —          5,612        —          —          5,612   

Insurance subsidiary investments

    —          —          110,227        —          110,227   

Investment in subsidiaries

    266,817        —          —          (266,817     —     

Intercompany

    2,503,209        —          —          (2,503,209     —     

Deferred tax assets

    —          —          12,387        (12,387     —     

Other

    52,623        92,231        53,615        —          198,469   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 2,822,649      $ 3,392,439      $ 705,818      $ (2,782,413   $ 4,138,493   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
LIABILITIES AND EQUITY          

Current liabilities:

         

Accounts payable

  $ 102      $ 196,326      $ 20,373      $ —        $ 216,801   

Salaries, wages and other compensation

    43        371,022        36,428        —          407,493   

Due to third party payors

    —          37,306        —          —          37,306   

Professional liability risks

    —          3,582        42,428        —          46,010   

Other accrued liabilities

    —          121,959        8,734        —          130,693   

Long-term debt due within one year

    7,000        96        3,524        —          10,620   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    7,145        730,291        111,487        —          848,923   

Long-term debt

    1,526,583        460        4,839        —          1,531,882   

Intercompany

    —          2,169,985        333,224        (2,503,209     —     

Professional liability risks

    —          108,853        108,864        —          217,717   

Deferred tax liabilities

    —          30,342        —          (12,387     17,955   

Deferred credits and other liabilities

    —          130,466        61,305        —          191,771   

Noncontrolling interests-redeemable

    —          —          9,704        —          9,704   

Commitments and contingencies

         

Equity:

         

Stockholders’ equity

    1,288,921        222,042        44,775        (266,817     1,288,921   

Noncontrolling interests-nonredeemable

    —          —          31,620        —          31,620   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    1,288,921        222,042        76,395        (266,817     1,320,541   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 2,822,649      $ 3,392,439      $ 705,818      $ (2,782,413   $ 4,138,493   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

31


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

 

Condensed Consolidating Statement of Cash Flows

 

    Three months ended June 30, 2012  

(In thousands)

  Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Net cash provided by (used in) operating activities

  $ 4,544      $ 49,506      $ (1,027   $ —        $ 53,023   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

         

Routine capital expenditures

    —          (26,131     (2,628     —          (28,759

Development capital expenditures

    —          (11,329     (1,047     —          (12,376

Acquisitions

    —          (17,420     —          —          (17,420

Acquisition deposit

    —          16,866        —          —          16,866   

Purchase of insurance subsidiary investments

    —          —          (7,425     —          (7,425

Sale of insurance subsidiary investments

    —          —          8,004        —          8,004   

Net change in insurance subsidiary cash and cash equivalents

    —          —          (1,363     —          (1,363

Change in other investments

    —          182        —          —          182   

Other

    —          (255     —          —          (255
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    —          (38,087     (4,459     —          (42,546
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

         

Proceeds from borrowings under revolving credit

    449,300        —          —          —          449,300   

Repayment of borrowings under revolving credit

    (457,500     —          —          —          (457,500

Repayment of other long-term debt

    (1,750     (23     (872     —          (2,645

Payment of deferred financing costs

    (270     —          —          —          (270

Contribution made by noncontrolling interest

    —          —          200        —          200   

Cash distributed to noncontrolling interests

    —          —          (2,133     —          (2,133

Change in intercompany accounts

    5,676        (4,210     (1,466     —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

    (4,544     (4,233     (4,271     —          (13,048
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

    —          7,186        (9,757     —          (2,571

Cash and cash equivalents at beginning of period

    —          23,587        16,550        —          40,137   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ —        $ 30,773      $ 6,793      $ —        $ 37,566   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

32


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

Condensed Consolidating Statement of Cash Flows (Continued)

 

    Three months ended June 30, 2011  

(In thousands)

  Parent
company/
issuer
    Guarantor
subsidiaries
    Non-guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Net cash provided by (used in) operating activities

  $ (43,091   $ 40,546      $ 7,397      $ —        $ 4,852   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

         

Routine capital expenditures

    —          (33,876     (74     —          (33,950

Development capital expenditures

    —          (14,309     —          —          (14,309

Acquisitions, net of cash acquired

    —          (682,124     30,172        —          (651,952

Purchase of insurance subsidiary investments

    —          —          (9,220     —          (9,220

Sale of insurance subsidiary investments

    —          —          8,533        —          8,533   

Net change in insurance subsidiary cash and cash equivalents

    —          —          (2,744     —          (2,744

Other

    —          (161     —          —          (161
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

    —          (730,470     26,667        —          (703,803
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

         

Proceeds from borrowings under revolving credit

    654,900        —          —          —          654,900   

Repayment of borrowings under revolving credit

    (814,900     —          —          —          (814,900

Proceeds from issuance of senior unsecured notes

    550,000        —          —          —          550,000   

Proceeds from issuance of term loan, net of discount

    693,000        —          —          —          693,000   

Repayment of other long-term debt

    —          (345,395     (271     —          (345,666

Payment of deferred financing costs

    (6,443     —          —          —          (6,443

Issuance of common stock

    1,604        —          —          —          1,604   

Change in intercompany accounts

    (1,035,425     1,052,015        (16,590     —          —     

Insurance subsidiary distribution

    —          —          —          —          —     

Other

    355        —          —          —          355   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

    43,091        706,620        (16,861     —          732,850   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

    —          16,696        17,203        —          33,899   

Cash and cash equivalents at beginning of period

    —          18,500        —          —          18,500   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ —        $ 35,196      $ 17,203      $ —        $ 52,399   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

33


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

Condensed Consolidating Statement of Cash Flows (Continued)

 

 

     Six months ended June 30, 2012  

(In thousands)

   Parent
company/
issuer
    Guarantor
subsidiaries
    Non-
guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Net cash provided by operating activities

   $ 6,975      $ 36,903      $ 5,720      $ —        $ 49,598   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Routine capital expenditures

     —          (47,071     (3,794     —          (50,865

Development capital expenditures

     —          (21,032     (1,966     —          (22,998

Acquisitions

     —          (67,868     —          —          (67,868

Sale of assets

     —          1,110        —          —          1,110   

Purchase of insurance subsidiary investments

     —          —          (21,198     —          (21,198

Sale of insurance subsidiary investments

     —          —          22,010        —          22,010   

Net change in insurance subsidiary cash and cash equivalents

     —          —          (14,486     —          (14,486

Change in other investments

     —          451        —          —          451   

Capital contribution to insurance subsidiary

     —          (8,600     —          8,600        —     

Other

     —          (1,004     —          —          (1,004
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     —          (144,014     (19,434     8,600        (154,848
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Proceeds from borrowings under revolving credit

     964,700        —          —          —          964,700   

Repayment of borrowings under revolving credit

     (854,500     —          —          —          (854,500

Repayment of other long-term debt

     (3,500     (46     (1,765     —          (5,311

Payment of deferred financing costs

     (313     —          —          —          (313

Contribution made by noncontrolling interest

     —          —          200        —          200   

Cash distributed to noncontrolling interests

     —          —          (3,521     —          (3,521

Change in intercompany accounts

     (113,362     116,105        (2,743     —          —     

Capital contribution to insurance subsidiary

     —          —          8,600        (8,600     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     (6,975     116,059        771        (8,600     101,255   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

     —          8,948        (12,943     —          (3,995

Cash and cash equivalents at beginning of period

     —          21,825        19,736        —          41,561   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ —        $ 30,773      $ 6,793      $ —        $ 37,566   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

34


Table of Contents

KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 13—CONDENSED CONSOLIDATING FINANCIAL INFORMATION (Continued)

Condensed Consolidating Statement of Cash Flows (Continued)

 

     Six months ended June 30, 2011  

(In thousands)

   Parent
company/
issuer
    Guarantor
subsidiaries
    Non-
guarantor
subsidiaries
    Consolidating
and
eliminating
adjustments
    Consolidated  

Net cash provided by (used in) operating activities

   $ (39,330   $ 85,090      $ 9,028      $ (3,500   $ 51,288   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Routine capital expenditures

     —          (58,594     (74     —          (58,668

Development capital expenditures

     —          (25,418     —          —          (25,418

Acquisitions, net of cash acquired

     —          (690,151     30,172        —          (659,979

Sale of assets

     —          1,714        —          —          1,714   

Purchase of insurance subsidiary investments

     —          —          (17,037     —          (17,037

Sale of insurance subsidiary investments

     —          —          27,189        —          27,189   

Net change in insurance subsidiary cash and cash equivalents

     —          —          (4,044     —          (4,044

Change in other investments

     —          1,000        —          —          1,000   

Other

     —          (29     —          —          (29
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     —          (771,478     36,206        —          (735,272
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Proceeds from borrowings under revolving credit

     1,100,100        —          —          —          1,100,100   

Repayment of borrowings under revolving credit

     (1,275,100     —          —          —          (1,275,100

Proceeds from issuance of senior unsecured notes

     550,000        —          —          —          550,000   

Proceeds from issuance of term loan, net of discount

     693,000        —          —          —          693,000   

Repayment of other long-term debt

     —          (345,417     (271     —          (345,688

Payment of deferred financing costs

     (6,860     —          —          —          (6,860

Issuance of common stock

     3,019        —          —          —          3,019   

Change in intercompany accounts

     (1,025,573     1,049,833        (24,260     —          —     

Insurance subsidiary distribution

     —          —          (3,500     3,500        —     

Other

     744        —          —          —          744   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     39,330        704,416        (28,031     3,500        719,215   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in cash and cash equivalents

     —          18,028        17,203        —          35,231   

Cash and cash equivalents at beginning of period

     —          17,168        —          —          17,168   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ —        $ 35,196      $ 17,203      $ —        $ 52,399   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 14—LEGAL AND REGULATORY PROCEEDINGS

The Company provides services in a highly regulated industry and has been subject to various legal actions (some of which are not insured) and regulatory and other governmental audits and investigations from time to time. These matters could (1) require the Company to pay substantial damages, fines, penalties or amounts in judgments or settlements, which individually or in the aggregate could exceed amounts, if any, that may be recovered under the Company’s insurance policies where coverage applies and is available; (2) cause the Company to incur substantial expenses; (3) require significant time and attention from the Company’s management; (4) subject the Company to sanctions including possible exclusions from the Medicare and Medicaid programs; and (5) cause the Company to close or sell one or more facilities or otherwise modify the way the Company conducts business. The ultimate resolution of these matters, whether as a result of litigation or settlement, could have a material adverse effect on the Company’s business, financial position, results of operations and liquidity.

In accordance with authoritative accounting guidance related to loss contingencies, the Company records an accrued liability for litigation and regulatory matters that are both probable and can be reasonably estimated. Additional losses in excess of amounts accrued may be reasonably possible. The Company reviews loss contingencies that are reasonably possible and determines whether an estimate of the possible loss or range of loss, individually or in aggregate, can be disclosed in the Company’s consolidated financial statements. These estimates are based upon currently available information for those legal and regulatory proceedings in which the Company is involved, taking into account the Company’s best estimate of losses for those matters for which such estimate can be made. The Company’s estimates involve significant judgment, given that (1) these legal and regulatory proceedings are in early stages; (2) discovery is not completed; (3) damages sought in these legal and regulatory proceedings can be unsubstantiated or indeterminate; (4) the matters present legal uncertainties or evolving areas of law; (5) there are often significant facts in dispute; and (6) there is a wide range of possible outcomes. Accordingly, the Company’s estimated loss or range of loss may change from time to time, and actual losses may be more or less than the current estimate. At this time, no estimate of the possible loss or range of loss, individually or in the aggregate, in excess of the amounts accrued, if any, can be made regarding the matters described below.

Set forth below are descriptions of the Company’s significant legal proceedings.

Medicare and Medicaid payment reviews, audits and investigations—as a result of the Company’s participation in the Medicare and Medicaid programs, the Company faces and is currently subject to various governmental reviews, audits and investigations to verify the Company’s compliance with these programs and applicable laws and regulations. The Company is routinely subject to audits under various government programs, such as the CMS Recovery Audit Contractor program, in which third party firms engaged by CMS conduct extensive reviews of claims data and medical and other records to identify potential improper payments to healthcare providers under the Medicare program. In addition, the Company, like other hospitals, nursing center operators and rehabilitation therapy service contractors, is subject to ongoing investigations by the U.S. Department of Health and Human Services Office of Inspector General into the billing of rehabilitation services provided to Medicare patients and general compliance with conditions of participation in the Medicare and Medicaid programs. Private pay sources such as third party insurance and managed care entities also often reserve the right to conduct audits. The Company’s costs to respond to and defend any such reviews, audits and investigations can be significant and are likely to increase in the current enforcement environment. These audits and investigations may require the Company to refund or retroactively adjust amounts that have been paid under the relevant government program or by other payors. Further, an adverse review, audit or investigation also could result in other adverse consequences, particularly if the underlying conduct is found to be pervasive or systemic. These consequences include (1) state or federal agencies imposing fines, penalties and other sanctions on the Company; (2) loss of the Company’s right to participate in the Medicare or Medicaid programs or one or more third party payor networks; and/or (3) damage to the Company’s reputation in various markets, which could adversely affect the Company’s ability to attract patients, residents and employees.

 

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KINDRED HEALTHCARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

NOTE 14—LEGAL AND REGULATORY PROCEEDINGS (Continued)

 

Whistleblower lawsuits—the Company is also subject to qui tam or “whistleblower” lawsuits under the False Claims Act and comparable state laws for allegedly submitting fraudulent bills for services to the Medicare and Medicaid programs. These lawsuits involve monetary damages, fines, attorneys’ fees and the award of bounties to private qui tam plaintiffs who successfully bring these lawsuits and to the respective government programs. The Company also could be subject to civil penalties (including the loss of the Company’s licenses to operate one or more facilities or healthcare activities), criminal penalties (for violations of certain laws and regulations), and exclusion of one or more facilities or healthcare activities from participation in the Medicare, Medicaid and other federal and state healthcare programs.

Employment-related lawsuits—the Company’s operations are subject to a variety of federal and state employment-related laws and regulations, including but not limited to the U.S. Fair Labor Standards Act, regulations of the Equal Employment Opportunity Commission, the Office of Civil Rights and state attorneys general, federal and state wage and hour laws and a variety of laws enacted by the federal and state governments that govern these and other employment-related matters. Accordingly, the Company is currently subject to employee-related claims, class action and other lawsuits and proceedings in connection with the Company’s operations, including but not limited to those related to alleged wrongful discharge, illegal discrimination and violations of equal employment and federal and state wage and hour laws. Because labor represents such a large portion of the Company’s operating costs, non-compliance with these evolving federal and state laws and regulations could subject the Company to significant back pay awards, fines and additional lawsuits and proceedings. These claims, lawsuits and proceedings are in various stages of adjudication or investigation and involve a wide variety of claims and potential outcomes. Based upon currently available information, the Company has recorded a $5 million loss provision related to these claims, lawsuits and proceedings in the second quarter of 2012, but the actual losses may be more than the provision for loss.

Minimum staffing lawsuits—various states in which the Company operates hospitals and nursing and rehabilitation centers have established minimum staffing requirements or may establish minimum staffing requirements in the future. While the Company seeks to comply with all applicable staffing requirements, the regulations in this area are complex and the Company may experience compliance issues from time to time. Failure to comply with such minimum staffing requirements may result in one or more facilities failing to meet the conditions of participation under relevant federal and state healthcare programs and the imposition of significant fines, damages or other sanctions. Private litigation involving these matters also has become more common, and certain of the Company’s facilities are the subject of a class action lawsuit involving claims that these facilities did not meet relevant staffing requirements from time to time since 2006.

Ordinary course matters—in addition to the matters described above, the Company is subject to investigations, claims and lawsuits in the ordinary course of business, including professional liability claims, particularly in the Company’s hospital and nursing and rehabilitation center operations. In many of these claims, plaintiffs’ attorneys are seeking significant fines and compensatory and punitive damages, along with attorneys’ fees. The Company maintains professional and general liability insurance in amounts and coverage that management believes are sufficient for the Company’s operations. However, the Company’s insurance may not cover all claims against the Company or the full extent of the Company’s liability.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Cautionary Statement

This Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements regarding the Company’s expected future financial position, results of operations, cash flows, financing plans, business strategy, budgets, capital expenditures, competitive positions, growth opportunities, plans and objectives of management and statements containing the words such as “anticipate,” “approximate,” “believe,” “plan,” “estimate,” “expect,” “project,” “could,” “should,” “will,” “intend,” “may” and other similar expressions, are forward-looking statements.

Such forward-looking statements are inherently uncertain, and stockholders and other potential investors must recognize that actual results may differ materially from the Company’s expectations as a result of a variety of factors, including, without limitation, those discussed below. Such forward-looking statements are based upon management’s current expectations and include known and unknown risks, uncertainties and other factors, many of which the Company is unable to predict or control, that may cause the Company’s actual results or performance to differ materially from any future results or performance expressed or implied by such forward-looking statements. These statements involve risks, uncertainties and other factors discussed below and detailed from time to time in the Company’s filings with the SEC. Factors that may affect the Company’s plans or results include, without limitation:

 

   

the impact of healthcare reform, which will initiate significant reforms to the United States healthcare system, including potential material changes to the delivery of healthcare services and the reimbursement paid for such services by the government or other third party payors, including reforms resulting from the Patient Protection and Affordable Care Act and the Healthcare Education and Reconciliation Act (collectively, the “ACA”). Healthcare reform is affecting certain of the Company’s businesses and the Company expects that it will impact all of them in some manner. There is also the possibility that implementation of the provisions expanding health insurance coverage or the entire ACA will be delayed, revised or eliminated as a result of efforts to repeal or amend the law. The U.S. Supreme Court recently upheld the constitutionality of the ACA. Future court proceedings, the 2012 presidential election and pending efforts in the U.S. Congress to repeal, amend or retract funding for various aspects of the ACA create additional uncertainty about the ultimate impact of the ACA on the Company and the healthcare industry. Due to the substantial regulatory changes that will need to be implemented by CMS and others, and the numerous processes required to implement these reforms, the Company cannot predict which healthcare initiatives will be implemented at the federal or state level, the timing of any such reforms, or the effect such reforms or any other future legislation or regulation will have on the Company’s business, financial position, results of operations and liquidity,

 

   

the impact of the rules issued by CMS on August 1, 2012 (the “2012 CMS Rule”) which, among other things, will reduce Medicare reimbursement to the Company’s LTAC hospitals in 2013 and beyond by imposing a budget neutrality adjustment and modifying the short-stay outlier rules,

 

   

the impact of the 2011 CMS Rules which significantly reduced Medicare reimbursement to nursing centers and changed payments for the provision of group therapy services effective October 1, 2011,

 

   

the impact of the Budget Control Act of 2011 which will automatically reduce federal spending by approximately $1.2 trillion split evenly between domestic and defense spending. At this time, the Company believes this will result in an automatic 2% reduction on each claim submitted to Medicare beginning February 1, 2013,

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Cautionary Statement (Continued)

 

   

changes in the reimbursement rates or the methods or timing of payment from third party payors, including commercial payors and the Medicare and Medicaid programs, changes arising from and related to the Medicare prospective payment system for LTAC hospitals, including potential changes in the Medicare payment rules, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, and changes in Medicare and Medicaid reimbursements for the Company’s LTAC hospitals, nursing and rehabilitation centers, IRFs and home health and hospice operations, and the expiration of the Medicare Part B therapy cap exception process,

 

   

the effects of additional legislative changes and government regulations, interpretation of regulations and changes in the nature and enforcement of regulations governing the healthcare industry,

 

   

the impact of the Medicare, Medicaid and SCHIP Extension Act of 2007 (the “SCHIP Extension Act”), including the ability of the Company’s hospitals to adjust to potential LTAC certification, medical necessity reviews and the moratorium on future hospital development,

 

   

the impact of the Company’s significantly increased levels of indebtedness as a result of the RehabCare Merger on the Company’s funding costs, operating flexibility and ability to fund ongoing operations, development capital expenditures or other strategic acquisitions with additional borrowings,

 

   

the Company’s ability to successfully pursue its development activities, including through acquisitions, and successfully integrate new operations, including the realization of anticipated revenues, economies of scale, cost savings and productivity gains associated with such operations, as and when planned, including the potential impact of unanticipated issues, expenses and liabilities associated with those activities,

 

   

the failure of the Company’s facilities to meet applicable licensure and certification requirements,

 

   

the further consolidation and cost containment efforts of managed care organizations and other third party payors,

 

   

the Company’s ability to meet its rental and debt service obligations,

 

   

the Company’s ability to operate pursuant to the terms of its debt obligations, and comply with its covenants thereunder, and its ability to operate pursuant to its master lease agreements with Ventas,

 

   

the condition of the financial markets, including volatility and weakness in the equity, capital and credit markets, which could limit the availability and terms of debt and equity financing sources to fund the requirements of the Company’s businesses, or which could negatively impact the Company’s investment portfolio,

 

   

national and regional economic, financial, business and political conditions, including their effect on the availability and cost of labor, credit, materials and other services,

 

   

the Company’s ability to control costs, particularly labor and employee benefit costs,

 

   

increased operating costs due to shortages in qualified nurses, therapists and other healthcare personnel,

 

   

the Company’s ability to attract and retain key executives and other healthcare personnel,

 

   

the increase in the costs of defending and insuring against alleged professional liability and other claims and the Company’s ability to predict the estimated costs related to such claims, including the impact of differences in actuarial assumptions and estimates compared to eventual outcomes,

 

   

the Company’s ability to successfully reduce (by divestiture of operations or otherwise) its exposure to professional liability and other claims,

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Cautionary Statement (Continued)

 

   

the Company’s ability to successfully dispose of unprofitable facilities,

 

   

events or circumstances which could result in the impairment of an asset or other charges, such as the impact of the Medicare reimbursement regulations that resulted in the Company recording significant impairment charges in 2011,

 

   

changes in generally accepted accounting principles or practices, and changes in tax accounting or tax laws (or authoritative interpretations relating to any of these matters), and

 

   

the Company’s ability to maintain an effective system of internal control over financial reporting.

Many of these factors are beyond the Company’s control. The Company cautions investors that any forward-looking statements made by the Company are not guarantees of future performance. The Company disclaims any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments.

General

The accompanying unaudited condensed consolidated financial statements, including the notes thereto, should be read in conjunction with the following discussion and analysis.

The Company is a healthcare services company that through its subsidiaries operates LTAC hospitals, IRFs, nursing and rehabilitation centers, assisted living facilities, a contract rehabilitation services business and a home health and hospice business across the United States. At June 30, 2012, the Company’s hospital division operated 118 LTAC hospitals (8,448 licensed beds) and six IRFs (259 licensed beds) in 26 states. The Company’s nursing center division operated 224 nursing and rehabilitation centers (27,196 licensed beds) and six assisted living facilities (341 licensed beds) in 27 states. The Company’s rehabilitation division provided rehabilitation services primarily in hospitals and long-term care settings. The Company’s home health and hospice division provided home health, hospice and private duty services from 52 locations in eight states.

RehabCare Merger

On June 1, 2011, the Company completed the RehabCare Merger. Upon consummation of the RehabCare Merger, each issued and outstanding share of RehabCare common stock was converted into the right to receive the Merger Consideration. Kindred issued approximately 12 million shares of its common stock in connection with the RehabCare Merger. The purchase price totaled $963 million and was comprised of $662 million in cash and $301 million of Kindred common stock at fair value. The Company also assumed $356 million of long-term debt in the RehabCare Merger, of which $345 million was refinanced on June 1, 2011. The operating results of RehabCare have been included in the accompanying unaudited condensed consolidated financial statements of the Company since June 1, 2011.

Operating results in the second quarter of 2011 included transaction costs totaling $19 million, financing costs totaling $12 million and severance costs totaling $15 million related to the RehabCare Merger. Operating results for the six months ended June 30, 2011 included transaction costs totaling $23 million, financing costs totaling $14 million and severance costs totaling $15 million related to the RehabCare Merger. In the accompanying unaudited condensed consolidated statement of operations, transaction costs were included in other operating expenses, financing costs were included in interest expense and severance costs were included in salaries, wages and benefits.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

General (Continued)

 

Discontinued operations

In recent years, the Company has completed several strategic divestitures to improve its future operating results. For accounting purposes, the operating results of these businesses have been classified as discontinued operations in the accompanying unaudited condensed consolidated statement of operations for all periods presented. Assets not sold at June 30, 2012 have been measured at the lower of carrying value or estimated fair value less costs of disposal and have been classified as held for sale in the accompanying unaudited condensed consolidated balance sheet.

Critical Accounting Policies

Management’s discussion and analysis of financial condition and results of operations are based upon the Company’s consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures of commitments and contingencies. The Company relies on historical experience and on various other assumptions that management believes to be reasonable under the circumstances to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.

The Company believes the following critical accounting policies, among others, affect the more significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue recognition

The Company has agreements with third party payors that provide for payments to each of its operating divisions. These payment arrangements may be based upon prospective rates, reimbursable costs, established charges, discounted charges or per diem payments. Net patient service revenue is recorded at the estimated net realizable amounts from Medicare, Medicaid, Medicare Advantage, 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 new information or final settlements.

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, skilled nursing and hospital customers, and individual patients and other customers. Estimated provisions for doubtful accounts are recorded to the extent it is probable that a portion or all of a particular account will not be collected.

In evaluating the collectibility of accounts receivable, the Company considers a number of factors, including the age of the accounts, changes in collection patterns, the composition of patient accounts by payor type, the status of ongoing disputes with third party payors and general industry conditions. Actual collections of accounts receivable in subsequent periods may require changes in the estimated provision for loss. Changes in these estimates are charged or credited to the results of operations in the period of the change.

The provision for doubtful accounts totaled $6 million and $8 million in the second quarter of 2012 and 2011, respectively, and $13 million and $14 million for the six months ended June 30, 2012 and 2011, respectively.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Critical Accounting Policies (Continued)

 

Allowances for insurance risks

The Company insures a substantial portion of its professional liability risks and workers compensation risks through its limited purpose insurance subsidiary. Provisions for loss for these risks are based upon management’s best available information including 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 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 the Company’s limited purpose insurance subsidiary have been discounted based upon actuarial estimates of claim payment patterns using a discount rate of 1% to 5% depending upon the policy year. The discount rate was 1% for the 2012 and 2011 policy years. The discount rates are based upon the risk free interest rate for the respective year. 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 allowance for professional liability risks aggregated $278 million at June 30, 2012 and $264 million at December 31, 2011. If the Company did not discount any of the allowances for professional liability risks, these balances would have approximated $281 million at June 30, 2012 and $267 million at December 31, 2011.

As a result of deterioration in professional liability and workers compensation underwriting results of the Company’s limited purpose insurance subsidiary in 2011, the Company made a capital contribution of $9 million during the six months ended June 30, 2012 to its limited purpose insurance subsidiary. Conversely, as a result of improved professional liability underwriting results of the Company’s limited purpose insurance subsidiary in 2010, the Company received a distribution of $3 million during the six months ended June 30, 2011 from its limited purpose insurance subsidiary. These transactions were completed in accordance with applicable regulations. Neither the contribution nor the distribution had any impact on earnings.

Changes in the number of professional liability claims and the cost to settle these claims significantly impact the allowance for professional liability risks. A relatively small variance between the Company’s estimated and 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 June 30, 2012 would impact the Company’s operating income by approximately $3 million.

The provision for professional liability risks (continuing operations), including the cost of coverage maintained with unaffiliated commercial insurance carriers, aggregated $20 million and $17 million in the second quarter of 2012 and 2011, respectively, and $39 million and $35 million for the six months ended June 30, 2012 and 2011, respectively.

Provisions for loss for workers compensation risks retained by the Company’s limited purpose insurance subsidiary are not discounted and amounts equal to the loss provision are funded annually. The allowance for workers compensation risks aggregated $182 million at June 30, 2012 and $171 million at December 31, 2011. The provision for workers compensation risks (continuing operations), including the cost of coverage maintained with unaffiliated commercial insurance carriers, aggregated $16 million and $14 million in the second quarter of 2012 and 2011, respectively, and $31 million and $27 million for the six months ended June 30, 2012 and 2011, respectively.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Critical Accounting Policies (Continued)

 

Accounting for income taxes

The provision for income taxes is based upon the Company’s estimate of annual 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.

The Company’s effective income tax rate was 41.4% and 34.3% in the second quarter of 2012 and 2011, respectively, and 41.1% and 43.6% for the six months ended June 30, 2012 and 2011, respectively. The variances in the effective income tax rates for both 2012 periods compared to the same periods in 2011 primarily related to the impact of lower pretax earnings in 2011 and the impact of the nondeductible income tax treatment of certain transaction costs in 2011 incurred in connection with the RehabCare Merger.

There are significant uncertainties with respect to capital loss carryforwards that could affect materially the realization of certain deferred tax assets. Accordingly, the Company has recognized deferred tax assets to the extent it is more likely than not they will be realized and a valuation allowance is provided for deferred tax assets to the extent that it is uncertain that the deferred tax asset will be realized. The Company recognized net deferred tax assets totaling $17 million at June 30, 2012 and net deferred tax liabilities totaling $0.2 million at December 31, 2011.

The Company is subject to various federal and state income tax audits in the ordinary course of business. Such audits could result in increased tax payments, interest and penalties. While the Company believes its tax positions are appropriate, there can be no assurance that the various authorities engaged in the examination of its income tax returns will not challenge the Company’s positions.

Valuation of long-lived assets, goodwill and intangible assets

The Company regularly reviews the carrying value of certain long-lived assets and finite lived 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 that the recorded amounts cannot be recovered 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 a master lease agreement as the lowest level for which there are independent, identifiable cash flows. Accordingly, the estimated cash flows of all facilities within a master lease agreement are aggregated for purposes of evaluating the carrying values of long-lived assets.

The Company’s intangible assets with finite lives are amortized in accordance with the authoritative guidance for goodwill and other intangible assets using the straight-line method over their estimated useful lives ranging from one to 20 years.

As a result of the RehabCare Merger, the Company acquired finite lived intangible assets consisting of customer relationships ($189 million), a trade name ($17 million) and non-compete agreements ($3 million) with estimated useful lives ranging from two to 15 years.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Critical Accounting Policies (Continued)

Valuation of long-lived assets, goodwill and intangible assets (Continued)

 

On July 29, 2011, CMS issued the 2011 CMS Rules. In connection with the preparation of the Company’s operating results for the third quarter of 2011, the Company determined that the impact of the 2011 CMS Rules was a triggering event in the third quarter of 2011 and accordingly tested the recoverability of its nursing and rehabilitation centers reporting unit goodwill, intangible assets and property and equipment asset groups impacted by the reduced Medicare payments. The Company recorded pretax impairment charges aggregating $27 million ($16 million net of income taxes) in the third quarter of 2011. The charges included $6 million of goodwill (which represented the entire nursing and rehabilitation centers reporting unit goodwill) and $21 million of property and equipment. In addition, the Company recorded pretax impairment charges aggregating $2 million ($1 million net of income taxes) in the fourth quarter of 2011, $0.3 million ($0.2 million net of income taxes) in the second quarter of 2012 and $1.2 million ($0.7 million net of income taxes) for the six months ended June 30, 2012 for necessary property and equipment expenditures in the same nursing and rehabilitation center asset groups. These charges reflected the amount by which the carrying value of certain assets exceeded their estimated fair value. The impairment charges did not impact the Company’s cash flows or liquidity.

During the fourth quarter of 2011, the estimated negative impact from changes in the reimbursement of group rehabilitation therapy services to Medicare beneficiaries was greater than expected, and as a result, the Company lowered its cash flow expectations for the Company’s skilled nursing rehabilitation services reporting unit, causing the carrying value of goodwill of this reporting unit to exceed its estimated fair value in testing the recoverability of goodwill. The Company recorded a pretax impairment charge of $46 million ($43 million net of income taxes) in the fourth quarter of 2011. The Company also reviewed the other intangible assets and long-lived assets related to the skilled nursing rehabilitation services reporting unit and determined there were no impairments of these assets. The impairment charge did not impact the Company’s cash flows or liquidity.

In accordance with the authoritative guidance for goodwill and other intangible assets, the Company is required to perform an impairment test for goodwill and indefinite-lived intangible assets 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 goodwill impairment test at the end of each fiscal year for each of its reporting units. A reporting unit is either an operating segment or one level below the operating segment, referred to as a component. When the components within the Company’s operating segments have similar economic characteristics, the Company aggregates the components of its operating segments into one reporting unit. Accordingly, the Company has determined that its reporting units are hospitals, nursing and rehabilitation centers, skilled nursing rehabilitation services, hospital rehabilitation services, home health and hospice. The carrying value of goodwill for each of the Company’s reporting units at June 30, 2012 and December 31, 2011 follows (in thousands):

 

     June 30,
2012
     December 31,
2011
 

Hospitals

   $ 747,777       $ 745,411   

Nursing and rehabilitation centers

     —           —     

Rehabilitation division:

     

Skilled nursing rehabilitation services

     107,899         107,026   

Hospital rehabilitation services

     168,019         167,753   
  

 

 

    

 

 

 
     275,918         274,779   

Home health and hospice division:

     

Home health

     49,429         49,254   

Hospice

     15,255         15,211   
  

 

 

    

 

 

 
     64,684         64,465   
  

 

 

    

 

 

 
   $ 1,088,379       $ 1,084,655   
  

 

 

    

 

 

 

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Critical Accounting Policies (Continued)

Valuation of long-lived assets, goodwill and intangible assets (Continued)

 

As a result of the RehabCare Merger, goodwill was assigned to the Company’s hospital reporting unit ($534 million), skilled nursing rehabilitation services reporting unit ($151 million) and hospital rehabilitation services reporting unit ($168 million).

The goodwill impairment test involves a two-step process. The first step is a comparison of each reporting unit’s fair value to its carrying value. If the carrying value of the reporting unit is greater than its fair value, there is an indication that impairment may exist and the second step must be performed to measure the amount of impairment loss. Based upon the results of the step one impairment test for goodwill for hospitals, hospital rehabilitation services, home health and hospice reporting units for the year ended December 31, 2011, no goodwill impairment charges were recorded in connection with the Company’s annual impairment test.

Since quoted market prices for the Company’s reporting units are not available, the Company applies judgment in determining the fair value of these reporting units for purposes of performing the goodwill impairment test. The Company relies on widely accepted valuation techniques, including discounted cash flow and market multiple analyses approaches, which capture both the future income potential of the reporting unit and the market behaviors and actions of market participants in the industry that includes the reporting unit. These types of analyses require the Company to make assumptions and estimates regarding future cash flows, industry-specific economic factors and the profitability of future business strategies. The discounted cash flow approach uses a projection of estimated operating results and cash flows that are discounted using a weighted average cost of capital. Under the discounted cash flow approach, the projection uses management’s best estimates of economic and market conditions over the projected period for each reporting unit including growth rates in the number of admissions, patient days, reimbursement rates, operating costs, rent expense and capital expenditures. Other significant estimates and assumptions include terminal value growth rates, changes in working capital requirements and weighted average cost of capital. The market multiple analysis estimates fair value by applying cash flow multiples to the reporting unit’s operating results. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics to the reporting units.

The Company has determined that during the six months ended June 30, 2012 there were no events or changes in circumstances since December 31, 2011 requiring an interim impairment test. Although the Company has determined that there was no other goodwill or other indefinite-lived intangible asset impairments as of June 30, 2012, adverse changes in the operating environment and related key assumptions used to determine the fair value of the Company’s reporting units and indefinite-lived intangible assets or declines in the value of the Company’s common stock may result in future impairment charges for a portion or all of these assets. Specifically, if the rate of growth of government and commercial revenues earned by the Company’s reporting units were to be less than projected or if healthcare reforms were to negatively impact the Company’s business, an impairment charge of a portion or all of these assets may be required. An impairment charge could have a material adverse effect on the Company’s business, financial position and results of operations, but would not be expected to have an impact on the Company’s cash flows or liquidity.

The Company’s indefinite-lived intangible assets consist of trade names, Medicare certifications and certificates of need. The fair values of the Company’s indefinite-lived intangible assets are derived from current market data and projections at a facility level which include management’s best estimates of economic and market conditions over the projected period including growth rates in the number of admissions, patient days, reimbursement rates, operating costs, rent expense and capital expenditures. Other significant estimates and assumptions include terminal value growth rates, changes in working capital requirements and weighted average cost of capital. Certificates of need intangible assets are estimated primarily using both a replacement cost methodology and an excess earnings method, a form of discounted cash flows, which is based upon the concept that net after-tax cash flows provide a return supporting all of the assets of a business enterprise.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Critical Accounting Policies (Continued)

Valuation of long-lived assets, goodwill and intangible assets (Continued)

 

At December 31, 2011, the carrying value of the Company’s certificates of need intangible assets exceeded its fair value as a result of declining earnings and cash flows related to five hospitals and two co-located nursing and rehabilitation centers in Massachusetts, all of which were acquired in 2006. The declining earnings and cash flows were attributable to a difficult LTAC operating environment in Massachusetts in which the Company was unable to achieve consistent operating results, as well as automatic future Medicare reimbursement reductions triggered in December 2011 by the Budget Control Act of 2011. In addition, the Company decided in the fourth quarter of 2011 to close one of the five hospitals. The pretax impairment charge related to the certificates of need totaled $54 million ($33 million net of income taxes). The Company reviewed the other long-lived assets related to these five hospitals and two co-located nursing and rehabilitation centers and determined there was no impairment. Based upon the results of the annual impairment test performed for the year ended December 31, 2011 for indefinite-lived intangible assets other than certificates of need intangible assets discussed above, no impairment charges were recorded.

As a result of the RehabCare Merger, the Company acquired indefinite-lived intangible assets consisting of trade names ($115 million), Medicare certifications ($76 million) and certificates of need ($8 million). The annual impairment test for these indefinite-lived intangible assets was performed as of May 1, 2012. No impairment charges were recorded in connection with this annual impairment test.

Recently Issued Accounting Requirements

In September 2011, the FASB issued authoritative guidance related to testing goodwill for impairment. The main provisions of the guidance state that an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step goodwill impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform Step 1 of the goodwill impairment test. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance is not expected to have a material impact on the Company’s business, financial position, results of operations or liquidity.

In July 2011, the FASB issued authoritative guidance related to the presentation and disclosure of patient service revenue, provision for bad debts, and the allowance for doubtful accounts for certain healthcare entities. The provisions of the guidance require healthcare entities that recognize significant amounts of patient service revenue at the time services are rendered, even though they do not assess a patient’s ability to pay, to present the provision for bad debts related to those revenues as a deduction from patient service revenue (net of contractual allowances and discounts), as opposed to an operating expense. All other entities would continue to present the provision for bad debts as an operating expense. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have an impact on the Company’s business, financial position, results of operations or liquidity.

In June 2011, the FASB issued authoritative guidance related to the presentation of other comprehensive income. The provisions of the guidance state that an entity has the option to present the total of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The statement(s) should be presented with equal prominence to the other primary financial statements. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s business, financial position, results of operations or liquidity.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Recently Issued Accounting Requirements (Continued)

 

In December 2011, the FASB amended its authoritative guidance issued in June 2011 related to the presentation of other comprehensive income. The provisions indefinitely defer the requirement to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented, for both interim and annual financial statements. All other requirements of the June 2011 update were not impacted by the amendment which remains effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s business, financial position, results of operations or liquidity.

In May 2011, the FASB issued authoritative guidance related to fair value measurements. The provisions of the guidance result in applying common fair value measurement and disclosure requirements in both United States generally accepted accounting principles and International Financial Reporting Standards. The amendments primarily change the wording used to describe many of the requirements in generally accepted accounting principles for measuring and disclosing information about fair value measurements. The guidance is effective for all interim and annual reporting periods beginning after December 15, 2011. The adoption of the guidance did not have a material impact on the Company’s business, financial position, results of operations or liquidity.

Results of Operations—Continuing Operations

Hospital division

Revenues increased 23% to $729 million in the second quarter of 2012 compared to $593 million in the same period in 2011 and increased 30% to $1.5 billion for the six months ended June 30, 2012 from $1.2 billion for the same period in 2011. Revenue growth in both periods was primarily a result of the RehabCare Merger and, to a lesser extent, favorable reimbursement rates and the increase in same-facility admissions. Revenues associated with the RehabCare Merger were $171 million and $349 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, and $51 million in the second quarter of 2011. Aggregate admissions increased 26% in the second quarter of 2012 and 33% for the six months ended June 30, 2012 compared to the same respective prior year periods, primarily as a result of the RehabCare Merger. Aggregate same-facility admissions increased 3% in both the second quarter of 2012 and for the six months ended June 30, 2012 compared to the same respective prior year periods.

Hospital operating margins increased in the second quarter of 2012 and for the six months ended June 30, 2012 compared to the same respective prior year periods, primarily as a result of favorable reimbursement rates and cost efficiencies associated with volume growth. Operating income included severance and other miscellaneous costs related to the closing of a regional office and three LTAC hospitals, the cancellation of a sub-acute unit project and employment-related lawsuits totaling $8 million and $10 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively. Operating income associated with the RehabCare Merger was $36 million and $76 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, and $11 million in the second quarter of 2011.

Average hourly wage rates were relatively unchanged in both the second quarter of 2012 and for the six months ended June 30, 2012 compared to the respective prior year periods. Employee benefit costs increased 23% in the second quarter of 2012 and 31% for the six months ended June 30, 2012 compared to the respective prior year periods, primarily as a result of the RehabCare Merger.

Professional liability costs were $11 million and $8 million in the second quarter of 2012 and 2011, respectively, and $21 million and $17 million for the six months ended June 30, 2012 and 2011, respectively. The increase in both periods was primarily a result of the RehabCare Merger.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Results of Operations—Continuing Operations (Continued)

 

Nursing center division

Revenues decreased 6% to $536 million in the second quarter of 2012 compared to $569 million in the same period of 2011 and decreased 5% to $1.1 billion for the six months ended June 30, 2012 from the same period in 2011. The decline in revenues in both periods was primarily a result of the 2011 CMS Rules and a decline in admissions. Same-facility admissions declined 4% in the second quarter of 2012 and 1% for the six months ended June 30, 2012 compared to the same respective prior year periods. Same-facility patient days declined 3% in the second quarter of 2012 and 2% for the six months ended June 30, 2012, compared to the same respective prior year periods, primarily as a result of declines in Medicare average length of stay.

Nursing center operating margins declined in the second quarter of 2012 and for the six months ended June 30, 2012 compared to the same respective prior year periods, primarily as a result of the 2011 CMS Rules.

Average hourly wage rates were relatively unchanged in both the second quarter of 2012 and for the six months ended June 30, 2012 compared to the respective prior year periods.

Professional liability costs were $9 million and $8 million in the second quarter of 2012 and 2011, respectively, and $17 million for both the six months ended June 30, 2012 and 2011.

Rehabilitation division

Skilled nursing rehabilitation services

Revenues increased to $255 million in the second quarter of 2012 compared to $161 million in the same period in 2011 and increased to $511 million for the six months ended June 30, 2012 from $276 million for the same period in 2011. Revenue growth in both periods was primarily attributable to the RehabCare Merger and, to a lesser extent, growth in the volume of services provided to existing customers. Revenues associated with the RehabCare Merger were $141 million and $280 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, and $46 million in the second quarter of 2011. Revenues derived from unaffiliated customers aggregated $198 million and $103 million in the second quarter of 2012 and 2011, respectively, and $395 million and $161 million for the six months ended June 30, 2012 and 2011, respectively.

Operating margins declined in the second quarter of 2012 and for the six months ended June 30, 2012 compared to the respective prior year periods, primarily as a result of the 2011 CMS Rules. Operating income associated with the RehabCare Merger was $13 million and $22 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, and $5 million in the second quarter of 2011.

Hospital rehabilitation services

Revenues increased to $74 million in the second quarter of 2012 compared to $39 million in the same period in 2011 and increased to $148 million for the six months ended June 30, 2012 from $61 million for the same period in 2011. Revenue growth in both periods was primarily attributable to the RehabCare Merger and, to a lesser extent, growth in new customers and the volume of services provided to existing customers. Revenues associated with the RehabCare Merger were $45 million and $89 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, and $16 million in the second quarter of 2011. Revenues derived from unaffiliated customers aggregated $46 million and $18 million in the second quarter of 2012 and 2011, respectively, and $92 million and $19 million for the six months ended June 30, 2012 and 2011, respectively.

Operating margins increased in the second quarter of 2012 and for the six months ended June 30, 2012 compared to the respective prior year periods, primarily attributable to improved operating efficiencies associated with the RehabCare Merger. Operating income associated with the RehabCare Merger was $10 million and $19 million in the second quarter of 2012 and for the six months ended June 30, 2012, respectively, and $4 million in the second quarter of 2011.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Results of Operations—Continuing Operations (Continued)

 

Home health and hospice division

Revenues increased to $29 million in the second quarter of 2012 compared to $11 million in the same period in 2011 and increased to $57 million for the six months ended June 30, 2012 from $19 million for the same period in 2011. Revenue growth in both periods was primarily attributable to two acquisitions completed after the second quarter of 2011. Operating margins increased in the second quarter of 2012 and for the six months ended June 30, 2012 compared to the respective prior year periods. Operating margins in the second quarter of 2011 and for the six months ended June 30, 2011 were negatively impacted by start-up and overhead costs in connection with the development of this business segment.

Corporate overhead

Operating income for the Company’s operating divisions excludes allocations of corporate overhead. These costs aggregated $44 million in the second quarter of both 2012 and 2011, and $87 million and $82 million for the six months ended June 30, 2012 and 2011, respectively. The increase for the six months ended June 30, 2012 was primarily attributable to increased costs of assuming the RehabCare operations. As a percentage of consolidated revenues, corporate overhead totaled 2.9% and 3.4% in the second quarter of 2012 and 2011, respectively, and totaled 2.8% and 3.3% for the six months ended June 30, 2012 and 2011, respectively.

Transaction costs

Operating results included transaction costs totaling $0.6 million and $20 million in the second quarter of 2012 and 2011, respectively, and $1 million and $24 million for the six months ended June 30, 2012 and 2011, respectively, primarily related to the RehabCare Merger. Transaction costs in all periods were included in other operating expenses. Operating results in the second quarter of 2011 and for the six months ended June 30, 2011 also included severance costs totaling $15 million related to the RehabCare Merger. Severance costs in both periods were included in salaries, wages and benefits.

Capital costs

Rent expense increased 12% to $107 million in the second quarter of 2012 compared to $96 million in the same period in 2011 and increased 15% to $215 million for the six months ended June 30, 2012 from $187 million for the same period in 2011. The increases in both periods resulted primarily from leases acquired in the RehabCare Merger, contractual inflation and contingent rent increases. Rent expense in the second quarter of 2012 and for the six months ended June 30, 2012 included lease cancellation charges of $1 million and $3 million, respectively, incurred in connection with the closing of three LTAC hospitals.

Depreciation and amortization expense increased 32% to $50 million in the second quarter of 2012 compared to $38 million in the same period in 2011 and increased 40% to $99 million for the six months ended June 30, 2012 compared to $71 million for the same period in 2011. The increase in both periods resulted from the RehabCare Merger and the Company’s ongoing capital expenditure program and hospital development projects.

Interest expense increased to $27 million in the second quarter of 2012 from $23 million in the same period in 2011 and increased to $53 million for the six months ended June 30, 2012 from $29 million for the same period in 2011. The increase in both periods was primarily attributable to increased borrowings associated with the RehabCare Merger and higher interest rates compared to the same periods in 2011. Interest expense included $12 million and $14 million in the second quarter of 2011 and for the six months ended June 30, 2011, respectively, of financing costs related to the RehabCare Merger.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Results of Operations—Continuing Operations (Continued)

 

Consolidated results

Income from continuing operations before income taxes aggregated $26 million in the second quarter of 2012 compared to losses from continuing operations before income taxes of $10 million in the same period in 2011. Income from continuing operations before income taxes aggregated $57 million for the six months ended June 30, 2012 compared to $28 million for the same period in 2011. Income from continuing operations aggregated $16 million in the second quarter of 2012 compared to losses from continuing operations of $6 million in the same period in 2011. Income from continuing operations aggregated $34 million for the six months ended June 30, 2012 compared to $16 million for the same period in 2011. Severance costs, lease cancellation charges and other miscellaneous costs related to the closing of a regional office and three LTAC hospitals, the cancellation of a sub-acute unit project, employment-related lawsuits, employee retention costs incurred in connection with the decision to allow leases to expire for 54 nursing and rehabilitation centers leased from Ventas, and transaction costs impacted the consolidated pretax operating results by $10 million ($6 million net of income taxes) in the second quarter of 2012 and $15 million ($9 million net of income taxes) for the six months ended June 30, 2012. Transaction, severance and financing costs primarily related to the RehabCare Merger negatively impacted the consolidated pretax operating results by $47 million ($30 million net of income taxes) in the second quarter of 2011 and $53 million ($34 million net of income taxes) for the six months ended June 30, 2011.

Results of Operations—Discontinued Operations

Discontinued operations was breakeven in the second quarter of 2012 compared to income of $0.6 million in the same period in 2011. Income from discontinued operations aggregated $0.1 million for the six months ended June 30, 2012 compared to $0.4 million for the same period in 2011.

Liquidity

Operating cash flows

Cash flows provided by operations (including discontinued operations) aggregated $50 million for the six months ended June 30, 2012 compared to $51 million for the same period in 2011. Operating cash flows were negatively impacted by lower accounts receivable collections for the six months ended June 30, 2012 compared to the same period in 2011, primarily as a result of Medicaid payments deferred by states until July and fiscal intermediary processing delays related to the 2011 CMS Rules. Operating cash flows for the six months ended June 30, 2012 were negatively impacted by $5 million ($3 million net of income taxes) of severance, lease cancellation and transaction payments. Operating cash flows for the six months ended June 30, 2011 were negatively impacted by $88 million ($69 million net of income taxes) of severance, transaction and financing payments, primarily related to the RehabCare Merger. Operating cash flows for the six months ended June 30, 2012 included a net federal income tax payment of $5 million and operating cash flows for the six months ended June 30, 2011 included a net federal income tax refund of $15 million.

The Company utilizes its ABL Facility to meet working capital needs and finance its acquisition and development activities. As a result, the Company typically carries minimal amounts of cash on its consolidated balance sheet. Based upon the Company’s expected operating cash flows and the availability of borrowings under the Company’s ABL Facility ($237 million at June 30, 2012), management believes that the Company has the necessary financial resources to satisfy its expected short-term and long-term liquidity needs.

New credit facilities and notes

In connection with the RehabCare Merger, the Company entered into the New Credit Facilities and the Notes. The Company used proceeds from the New Credit Facilities and the Notes to pay the Merger Consideration, repay all amounts outstanding under the Company’s and RehabCare’s previous credit facilities and to pay transaction

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Liquidity (Continued)

New credit facilities and notes (Continued)

 

costs. The amounts outstanding under the Company’s and RehabCare’s former credit facilities that were repaid at the RehabCare Merger closing were $390 million and $345 million, respectively. The New Credit Facilities have incremental facility capacity in an aggregate amount between the two facilities of $200 million, subject to meeting certain conditions, including a specified senior secured leverage ratio with respect to the Term Loan Facility. In connection with these new credit arrangements, the Company paid $46 million of lender fees related to debt issuance that were capitalized as deferred financing costs and paid $13 million of other financing costs that were charged to interest expense during 2011.

All obligations under the New Credit Facilities are fully and unconditionally guaranteed, subject to certain customary release provisions, by substantially all of the Company’s existing and future direct and indirect domestic 100% owned subsidiaries, as well as certain non-100% owned domestic subsidiaries as the Company may determine from time to time in its sole discretion. The Notes are guaranteed by substantially all of the Company’s domestic 100% owned subsidiaries.

The agreements governing the New Credit Facilities and the indenture governing the Notes include a number of restrictive covenants that, among other things and subject to certain exceptions and baskets, impose operating and financial restrictions on the Company and certain of its subsidiaries. In addition, the Company is required to comply with a minimum fixed charge coverage ratio and a maximum total leverage ratio under the New Credit Facilities. These financing agreements governing the New Credit Facilities and the indenture governing the Notes also contain customary affirmative covenants and events of default. The Company was in compliance with the terms of the New Credit Facilities and the indenture governing the Notes at June 30, 2012.

ABL Facility

The ABL Facility has a five-year tenor and is secured by a first priority lien on eligible accounts receivable, cash, deposit accounts, and certain other assets and property and proceeds from the foregoing (the “First Priority ABL Collateral”). The ABL Facility has a second priority lien on substantially all of the Company’s other assets and properties. As of June 30, 2012, the Company had $404 million outstanding under the ABL Facility. In addition, approximately $9 million of letters of credit were issued under the ABL Facility.

Borrowings under the ABL Facility bear interest at a rate per annum equal to the applicable margin plus, at the Company’s option, either (1) LIBOR determined by reference to the costs of funds for eurodollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, or (2) a base rate determined by reference to the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the federal funds effective rate plus one-half of 1.00% and (c) LIBOR as described in subclause (1) plus 1.00%. At June 30, 2012, the applicable margin for borrowings under the ABL Facility was 2.75% with respect to LIBOR borrowings and 1.75% with respect to base rate borrowings. The applicable margin is subject to adjustment each fiscal quarter, based upon average historical excess availability during the preceding quarter.

Term Loan Facility

The Term Loan Facility has a tenor of seven years and is secured by a first priority lien on substantially all of the Company’s assets and properties other than the First Priority ABL Collateral and a second priority lien on the First Priority ABL Collateral. The Term Loan Facility net proceeds at the RehabCare Merger totaled $693 million, net of a $7 million original issue discount that will be amortized over the tenor of the Term Loan Facility.

Borrowings under the Term Loan Facility bear interest at a rate per annum equal to an applicable margin plus, at the Company’s option, either (1) LIBOR determined by reference to the costs of funds for eurodollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, or (2) a base rate determined by

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Liquidity (Continued)

New credit facilities and notes (Continued)

Term Loan Facility (Continued)

 

reference to the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the federal funds effective rate plus one-half of 1.00% and (c) LIBOR described in subclause (1) plus 1.00%. LIBOR is subject to an interest rate floor of 1.50%. The applicable margin for borrowings under the Term Loan Facility is 3.75% with respect to LIBOR borrowings and 2.75% with respect to base rate borrowings.

In December 2011, the Company entered into two interest rate swap agreements to hedge its floating interest rate on an aggregate of $225 million of outstanding Term Loan Facility debt. The interest rate swaps have an effective date of January 9, 2012, and expire on January 11, 2016. The Company is required to make payments based upon a fixed interest rate of 1.8925% calculated on the notional amount of $225 million. In exchange, the Company will receive interest on $225 million at a variable interest rate that is based upon the three-month LIBOR, subject to a minimum rate of 1.5%. The Company determined the interest rate swaps continue to be effective cash flow hedges at June 30, 2012. The fair value of the interest rate swaps recorded in other accrued liabilities was $2 million and $1 million at June 30, 2012 and December 31, 2011, respectively.

Notes

In connection with the RehabCare Merger, the Company completed a private placement of the Notes. The Notes bear interest at an annual rate equal to 8.25% and are senior unsecured obligations of the Company and the subsidiary guarantors, ranking pari passu with all of their respective existing and future senior unsubordinated indebtedness. The indenture contains certain restrictive covenants that will, among other things, limit the Company and certain of its subsidiaries’ ability to incur, assume or guarantee additional indebtedness; pay dividends; make distributions or redeem or repurchase stock; restrict dividends, loans or asset transfers from the Company’s subsidiaries; sell or otherwise dispose of assets; and enter into transactions with affiliates. These covenants are subject to a number of limitations and exceptions. The indenture also contains customary events of default.

Pursuant to a registration rights agreement, the Company filed with the SEC a registration statement related to an offer to exchange the Notes for an issue of SEC-registered notes with substantially identical terms. The exchange offer commenced on October 13, 2011 and was completed on November 10, 2011.

Other financing activities

As a result of deterioration in professional liability and workers compensation underwriting results of the Company’s limited purpose insurance subsidiary in 2011, the Company made a capital contribution of $9 million during the six months ended June 30, 2012 to its limited purpose insurance subsidiary. Conversely, as a result of improved professional liability underwriting results of the Company’s limited purpose insurance subsidiary in 2010, the Company received a distribution of $3 million during the six months ended June 30, 2011 from its limited purpose insurance subsidiary. These transactions were completed in accordance with applicable regulations. Neither the contribution nor the distribution had any impact on earnings.

Capital Resources

Capital expenditures and acquisitions

Excluding the RehabCare Merger and acquisitions, routine capital expenditures (expenditures necessary to maintain existing facilities that generally do not increase capacity or add services) totaled $51 million for the six months ended June 30, 2012 compared to $59 million for the same period in 2011. Hospital development capital expenditures (primarily replacement facility construction) totaled $21 million for the six months ended June 30, 2012 compared to $14 million for the same period in 2011. Nursing and rehabilitation center development capital

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Capital Resources (Continued)

Capital expenditures and acquisitions (Continued)

 

 

expenditures (primarily the addition of transitional care services for higher acuity patients) totaled $2 million for the six months ended June 30, 2012 compared to $11 million for the same period in 2011. Excluding acquisitions, the Company anticipates that routine capital spending for 2012 should approximate $125 million to $135 million, hospital development capital spending should approximate $30 million to $35 million and nursing and rehabilitation center development capital spending should approximate $10 million. Management expects that substantially all of these expenditures will be financed through internal sources. Management believes that its capital expenditure program is adequate to improve and equip existing facilities. At June 30, 2012, the estimated cost to complete and equip construction in progress approximated $25 million.

The RehabCare Merger purchase price totaled $963 million and was comprised of $662 million in cash and $301 million of Kindred common stock.

Excluding the RehabCare Merger, the Company financed acquisitions with either operating cash flows or its ABL Facility. These expenditures totaled $68 million for the six months ended June 30, 2012 compared to $18 million for the same period in 2011.

Renewal of Ventas facilities

On April 27, 2012, the Company provided Ventas with notices to renew the Renewal Facilities for an additional five years. The current lease term for the Renewal Facilities is scheduled to expire in April 2013.

Under its master lease agreements with Ventas, the Company had 73 nursing and rehabilitation centers and 16 LTAC hospitals within ten separate renewal bundles subject to lease renewals. Each renewal bundle contains both nursing and rehabilitation centers and LTAC hospitals. The master lease agreements require that the Company renew all or none of the facilities within a renewal bundle.

The Company has renewed three renewal bundles containing the Renewal Facilities. The Renewal Facilities contain 2,178 licensed nursing and rehabilitation center beds and 616 licensed hospital beds and generated revenues of approximately $434 million for the year ended December 31, 2011. The current annual rent for the Renewal Facilities approximates $46 million.

The Company did not renew seven renewal bundles containing 54 nursing and rehabilitation centers and ten LTAC hospitals. These facilities contain 6,140 licensed nursing and rehabilitation center beds and 1,066 licensed hospital beds and generated revenues of approximately $790 million for the year ended December 31, 2011. The current annual rent for these facilities approximates $77 million.

On May 24, 2012, the Company entered into a new master lease agreement with Ventas for the ten LTAC hospitals that the Company had previously announced it did not intend to renew. The new master lease agreement will be effective on May 1, 2013 and will have a term of ten years with three five-year renewal options. The annual rent for the new lease will be $28 million and is subject to annual increases based on the increase in the consumer price index (subject to an annual 4% cap). The current annual rent for these ten LTAC hospitals approximates $22 million. These ten LTAC hospitals contain 1,066 licensed hospital beds and generated revenues of approximately $276 million for the year ended December 31, 2011. The terms of the new master lease agreement are substantially similar to the terms of the other master lease agreements between Kindred and Ventas.

On May 24, 2012, the Company and Ventas also entered into a separate agreement to provide Ventas with more flexibility to accelerate the transfer of the 54 nursing and rehabilitation centers currently leased by the Company that are scheduled to expire on April 30, 2013. The Company will continue to operate these nursing and rehabilitation centers and include them in its results from continuing operations through the expiration of the lease term in April 2013.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Other Information

Effects of inflation and changing prices

 

The Company derives a substantial portion of its revenues from the Medicare and Medicaid programs. Congress and certain state legislatures have enacted or may enact additional significant cost containment measures limiting the Company’s ability to recover its cost increases through increased pricing of its healthcare services. Medicare revenues in LTAC hospitals and nursing centers are subject to fixed payments under the Medicare prospective payment systems.

Medicaid reimbursement rates in many states in which the Company operates nursing and rehabilitation centers also are based upon 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.

Various healthcare reform provisions became law upon the enactment of the ACA. The reforms contained in the ACA are affecting certain of the Company’s businesses and the Company expects that it will impact all of them in some manner. Several of the reforms are very significant and could ultimately change the nature of the Company’s services, the methods of payment for the Company’s services and the underlying regulatory environment. The reforms include possible modifications to the conditions of qualification for payment, bundling payments to cover both acute and post-acute care and the imposition of enrollment limitations on new providers. In addition, a primary goal of healthcare reform is to reduce costs, which includes reductions in the reimbursement paid to the Company and other healthcare providers. Moreover, healthcare reform could negatively impact insurance companies, other third party payors, the Company’s customers, as well as other healthcare providers, which may in turn negatively impact the Company’s business. As such, these healthcare reforms or other similar healthcare reforms could have a material adverse effect on the Company’s business, financial position, results of operations and liquidity. There is also the possibility that implementation of the provisions expanding health insurance coverage or the entire ACA will be delayed, revised or eliminated as a result of efforts to repeal or amend the law. The U.S. Supreme Court recently upheld the constitutionality of the ACA. Future court proceedings, the 2012 presidential election and pending efforts in the U.S. Congress to repeal, amend or retract funding for various aspects of the ACA create additional uncertainty about the ultimate impact of the ACA on the Company and the healthcare industry. Due to the substantial regulatory changes that will need to be implemented by CMS and others, and the numerous processes required to implement these reforms, the Company cannot predict which healthcare initiatives will be implemented at the federal or state level, the timing of any such reforms, or the effect such reforms or any other future legislation or regulation will have on the Company’s business, financial position, results of operations and liquidity.

The ACA enacted a series of reductions to the annual market basket payment updates for LTAC hospitals. Congress also mandated that the annual market basket payment update for a variety of providers, including LTAC hospitals, nursing centers, IRFs, hospice providers and home health providers, be reduced for a “productivity adjustment” determined by CMS. These productivity adjustments may vary and will be determined annually by CMS. The productivity adjustments for LTAC hospitals, IRFs and nursing centers were implemented on October 1, 2011. The productivity adjustments for hospice providers and home health providers are to be implemented on October 1, 2012 and October 1, 2014, respectively.

The Budget Control Act of 2011, enacted on August 2, 2011, increased the United States debt ceiling in connection with deficit reductions over the next ten years. In accordance with the Budget Control Act of 2011, $1.2 trillion in domestic and defense spending reductions will automatically begin February 1, 2013, split evenly between domestic and defense spending. Payments to Medicare providers are subject to these automatic spending reductions, subject to a 2% cap. At this time, the Company believes this will result in an automatic 2% reduction on each claim submitted to Medicare beginning February 1, 2013. Reductions to Medicare and Medicaid reimbursement resulting from the Budget Control Act of 2011 could have a material adverse effect on the Company’s business, financial position, results of operations and liquidity.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Other Information (Continued)

Effects of inflation and changing prices (Continued)

 

The Long-Term Acute Care Prospective Payment System (“LTAC PPS”) maintains LTAC hospitals as a distinct provider type, separate from short-term acute care hospitals. Only providers certified as LTAC hospitals may be paid under this system. To maintain certification under LTAC PPS, the average length of stay of fee for service Medicare patients must be at least 25 days.

On August 1, 2012, CMS issued the 2012 CMS Rule. Included in the 2012 CMS Rule is (1) a market basket increase to the standard federal payment rate of 2.6%; (2) offsets to the standard federal payment rate mandated by the ACA of: (a) 0.7% to account for the effect of a productivity adjustment, and (b) 0.1% as required by statute; (3) a wage level budget neutrality factor of 0.999265 applied to the adjusted standard federal payment rate; (4) adjustments to area wage indexes; and (5) a decrease in the high cost outlier threshold per discharge to $15,408. Effective December 29, 2012, the 2012 CMS Rule also would (1) begin a three-year phase-in of a 3.75% budget neutrality adjustment which would reduce LTAC hospital rates by 1.3% in 2013; and (2) restore a payment reduction that would limit payments for very short-stay outliers that would reduce the Company’s LTAC hospital payments by approximately 0.5%. The 2012 CMS Rule also (1) provides for a one-year extension of the existing moratorium on the “25 Percent Rule” (described below) pending the results of an ongoing research initiative to re-define the role of LTAC hospitals in the Medicare program, and (2) allows for the expiration of the current moratorium on the development or expansion of LTAC hospitals on December 29, 2012.

In aggregate, based upon its review of the 2012 CMS Rule, the Company expects that LTAC Medicare payment rates will decline slightly in 2013 compared to current rates. The 2012 CMS Rule does not include the impact of a 2% sequestration payment reduction mandated by Congress that is expected to begin in February 2013.

CMS is currently evaluating various certification criteria for designating a hospital as a LTAC hospital. If such certification criteria were developed and enacted into legislation, the Company’s hospitals may not be able to maintain their status as LTAC hospitals or may need to adjust their operations.

The SCHIP Extension Act became law on December 29, 2007. This legislation provides for, among other things:

 

  (1) a mandated study by the Secretary of Health and Human Services on the establishment of LTAC hospital certification criteria;

 

  (2) enhanced medical necessity review of LTAC hospital cases;

 

  (3) a three-year moratorium on the establishment of a LTAC hospital or satellite facility, subject to exceptions for facilities under development;

 

  (4) a three-year moratorium on an increase in the number of licensed beds at a LTAC hospital or satellite facility, subject to exceptions for states where there is only one other LTAC hospital and upon request following the closure or decrease in the number of licensed beds at a LTAC hospital within the state;

 

  (5) a three-year moratorium on the application of a one-time budget neutrality adjustment to payment rates to LTAC hospitals under LTAC PPS;

 

  (6) a three-year moratorium on very short-stay outlier payment reductions to LTAC hospitals initially implemented on May 1, 2007;

 

  (7) a three-year moratorium on the application of the policy known as the “25 Percent Rule” to freestanding LTAC hospitals;

 

  (8) a three-year period during which LTAC hospitals that are co-located with another hospital may admit up to 50% of their patients from their co-located hospital and still be paid according to LTAC PPS;

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Other Information (Continued)

Effects of inflation and changing prices (Continued)

 

  (9) a three-year period during which LTAC hospitals that are co-located with an urban single hospital or a hospital that generates more than 25% of the Medicare discharges in a metropolitan statistical area (“MSA Dominant hospital”) may admit up to 75% of their patients from such urban single hospital or MSA Dominant hospital and still be paid according to LTAC PPS; and

 

  (10) the elimination of the July 1, 2007 market basket increase in the standard federal payment rate of 0.71%, effective for discharges occurring on or after April 1, 2008.

The ACA revised certain provisions of the SCHIP Extension Act. The moratoriums on the establishment of new LTAC hospitals or satellites and bed increases at LTAC hospitals or satellites, the application of a one-time budget neutrality adjustment to rates, the payment reductions due to the very short-stay outlier provisions and application of the “25 Percent Rule” to freestanding hospitals were extended from three years to five years. In addition, the periods during which LTAC hospitals may admit up to 50% of their patients from co-located hospitals and during which LTAC hospitals may admit up to 75% of their patients from a MSA Dominant hospital were extended from three years to five years as well. The 2012 CMS Rule extended by one additional year the moratorium on the application of the “25 Percent Rule” to freestanding hospitals and added one additional year during which LTAC hospitals may admit up to 50% of their patients from co-located hospitals and during which LTAC hospitals may admit up to 75% of their patients from a MSA Dominant hospital.

CMS has regulations governing payments to LTAC hospitals that are co-located with another hospital (a “HIH”). The rules generally limit Medicare payments to the HIH if the Medicare admissions to the HIH from its co-located hospital exceed 25% of the total Medicare discharges for the HIH’s cost reporting period, the “25 Percent Rule.” There are limited exceptions for admissions from rural, urban single and MSA Dominant hospitals. Admissions that exceed this “25 Percent Rule” are paid using the short-term acute care inpatient payment system (“IPPS”). Patients transferred after they have reached the short-term acute care outlier payment status are not counted toward the admission threshold. Patients admitted prior to meeting the admission threshold, as well as Medicare patients admitted from a non co-located hospital, are eligible for the full payment under LTAC PPS. If the HIH’s admissions from the co-located hospital exceed the limit in a cost reporting period, Medicare will pay the lesser of (1) the amount payable under LTAC PPS or (2) the amount payable under IPPS. At June 30, 2012, the Company operated 27 HIHs with 1,026 licensed beds.

On May 1, 2007, CMS issued regulatory changes regarding Medicare reimbursement for LTAC hospitals (the “2007 Final Rule”). In the 2007 Final Rule, the “25 Percent Rule” was expanded to all LTAC hospitals, regardless of whether they are co-located with another hospital. Under the 2007 Final Rule, all LTAC hospitals were to be paid LTAC PPS rates for admissions from a single referral source up to 25% of aggregate Medicare admissions. Patients reaching high cost outlier status in the short-term hospital were not to be counted when computing the 25% limit. Admissions beyond the 25% threshold were to be paid at a lower amount based upon IPPS. However, as set forth above, the SCHIP Extension Act initially placed a three-year moratorium on the expansion of the “25 Percent Rule” to freestanding hospitals. That moratorium was extended to five years by the ACA. This moratorium was further extended for one additional year under the 2012 CMS Rule. In addition, the SCHIP Extension Act initially provided for a three-year period during which (1) LTAC hospitals may admit up to 50% of their patients from their co-located hospitals and still be paid according to LTAC PPS; and (2) LTAC hospitals that are co-located with an urban single hospital or a MSA Dominant hospital may admit up to 75% of their patients from such urban single or MSA Dominant hospital and still be paid according to LTAC PPS. Those periods also were extended to five years under the ACA and one additional year under the 2012 CMS Rule.

On July 30, 2010, CMS issued final regulations regarding Medicare reimbursement for LTAC hospitals for the fiscal year beginning October 1, 2010. Included in those final regulations is (1) a market basket increase to the standard federal payment rate of 2.5%; (2) an offset of 2.5% applied to the standard federal payment rate to account for the effect of documentation and coding changes; (3) an offset of 0.5% applied to the standard federal payment

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Other Information (Continued)

Effects of inflation and changing prices (Continued)

 

rate as mandated by the ACA; (4) adjustments to area wage indexes; and (5) an increase in the high cost outlier threshold per discharge to $18,785. CMS indicated that all of these changes will result in a 0.5% increase to average Medicare payments to LTAC hospitals.

On August 1, 2011, CMS issued final regulations regarding Medicare reimbursement for LTAC hospitals for the fiscal year beginning October 1, 2011. Included in the final regulations is (1) a market basket increase to the standard federal payment rate of 2.9%; (2) offsets to the standard federal payment rate mandated by the ACA of: (a) 1.0% to account for the effect of a productivity adjustment, and (b) 0.1% as required by statute; (3) a wage level budget neutrality factor of 0.99775 applied to the adjusted standard federal payment rate; (4) adjustments to area wage indexes; and (5) a decrease in the high cost outlier threshold per discharge to $17,931. CMS has projected the impact of these changes will result in a 2.5% increase to average Medicare payments to LTAC hospitals. Management believes that the impact of these changes to LTAC PPS would result in an approximate 0.7% increase in payments to the Company’s LTAC hospitals.

On August 2, 2011, the Long-Term Care Hospital Improvement Act of 2011 was introduced into the United States Senate (the “LTAC Legislation”) and is currently pending review by the United States Senate Finance Committee. If enacted, the LTAC Legislation would implement new patient and facility criteria for LTAC hospitals and alleviate the negative impact of various scheduled Medicare reimbursement adjustments. The LTAC Legislation provides for patient criteria to ensure that LTAC hospital patients are physician screened prior to admission and throughout their stay for the appropriateness of their stay in a LTAC hospital. In addition, facility criteria would establish common requirements for the programmatic, personnel and clinical operations of a LTAC hospital. The LTAC Legislation further provides that at least 70% of patients must be medically complex in order for a hospital to maintain its Medicare certification as a LTAC hospital. The LTAC Legislation also would repeal the “25 Percent Rule” for all LTAC hospitals, the scheduled very short-stay outlier payment reductions and the one-time budget neutrality adjustment requirement. There can be no assurances that the LTAC Legislation will be enacted in its current form or at all.

The Company cannot predict the ultimate long-term impact of LTAC PPS. This payment system is subject to significant change. Slight variations in patient acuity or length of stay could significantly change Medicare revenues generated under LTAC PPS. In addition, the Company’s hospitals may not be able to appropriately adjust their operating costs to changes in patient acuity and length of stay or to changes in reimbursement rates. In addition, there can be no assurance that LTAC PPS will not have a material adverse effect on revenues from commercial third party payors. Various factors, including a reduction in average length of stay, have negatively impacted revenues from commercial third party payors in recent years.

On July 29, 2011, CMS issued final regulations regarding Medicare reimbursement for IRFs for the fiscal year beginning October 1, 2011. Included in these final regulations are (1) a market basket increase to the standard payment conversion factor of 2.9%; (2) offsets to the standard payment conversion factor mandated by the ACA of: (a) 1.0% to account for the effect of a productivity adjustment, and (b) 0.1% as required by statute; (3) a wage level budget neutrality factor of 0.9988 applied to the standard payment conversion factor; (4) a case mix group budget neutrality factor of 0.9988 applied to the standard payment conversion factor; (5) adjustments to area wage indexes; and (6) a decrease in the high cost outlier threshold per discharge to $10,660. CMS has projected the impact of these changes will result in a 2.2% increase to average Medicare payments to IRFs.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Other Information (Continued)

Effects of inflation and changing prices (Continued)

 

On July 25, 2012, CMS issued final regulations regarding Medicare reimbursement for IRFs for the fiscal year beginning October 1, 2012. Included in these final regulations are (1) a market basket increase to the standard payment conversion factor of 2.7%; (2) offsets to the standard payment conversion factor mandated by the ACA of: (a) 0.7% to account for the effect of a productivity adjustment, and (b) 0.1% as required by statute; (3) adjustments to area wage indexes; and (4) a decrease in the high cost outlier threshold per discharge to $10,466. CMS has projected the impact of these changes will result in a 2.1% increase to average Medicare payments to IRFs.

On July 16, 2010, CMS issued a notice that updates the payment rates for nursing centers for the fiscal year beginning October 1, 2010. That notice provided for an increase in rates of 1.7%, which is comprised of a market basket increase of 2.3% less a forecast error adjustment of 0.6%. In addition, for the fiscal year beginning October 1, 2010, CMS increased the number of resource utilization group (“RUG”) categories for nursing centers from 53 to 66 (i.e., RUGs IV) and amended the criteria, including the provision of therapy services, used to classify patients into these categories. CMS indicated that these changes would be enacted in a budget neutral manner. CMS began paying claims using the RUGs IV system effective October 1, 2010. Based upon management’s experience, these final regulations resulted in increased payments to the Company for the federal fiscal year ending September 30, 2011. The therapy time requirements to qualify for rehabilitation RUG categories are unchanged under RUGs IV, however the regulatory changes altered how minutes were allocated to calculate the RUGs scores using the most recent clinical assessment tool of the minimum data set (“MDS 3.0”). Rather than count all therapy time that a nursing center patient receives, rehabilitation providers must now allocate therapy minutes between the patients being served during concurrent therapy sessions. In addition, the number of patients that a therapist/assistant may treat concurrently is limited to two patients. These changes have required the Company to employ more therapists to provide additional individual therapy minutes.

CMS issued the 2011 CMS Rules on July 29, 2011, updating Medicare payment rates for skilled nursing centers effective October 1, 2011. The 2011 CMS Rules impose (1) a negative adjustment to RUGs IV therapy rates, and (2) a net market basket increase of 1.7% consisting of (a) a 2.7% market basket inflation increase, less (b) a 1.0% adjustment to account for the effect of a productivity adjustment. CMS has projected the impact of these changes will result in an 11.1% decrease in payments to skilled nursing and rehabilitation centers. In addition to these rate changes, the 2011 CMS Rules introduced additional changes to RUG calculations along with adding additional patient assessments. Under the 2011 CMS Rules, group therapy is defined as therapy sessions with four patients who are performing similar therapy activities. In addition, for purposes of assigning patients to RUGs IV payment categories, the minutes of group therapy are divided by four with 25% of the minutes being allocated to each patient. The 2011 CMS Rules also clarify the circumstances for reporting breaks in care of three or more days of therapy and also implement a new change of therapy assessment that is designed to allocate the patient to the RUG level that represents the treatment provided in the last seven days. Both changes are likely to produce alterations in the RUG scores billed for the patient along with generating additional patient assessments. The Company’s rehabilitation division has hired additional therapists to facilitate the provision of additional individual minutes to address patient needs. The Company believes that the 2011 CMS Rules could reduce its annual revenues by approximately $100 million to $110 million in the Company’s nursing center business and negatively impact the Company’s rehabilitation therapy business by approximately $40 million to $50 million on an annual basis.

In February 2012, Congress passed the Job Creation Act of 2012 which provides for reductions in reimbursement of Medicare bad debts at the Company’s nursing and rehabilitation centers. The Job Creation Act of 2012 provides for a phase-in of the reduction in the rate of reimbursement for bad debts of patients that are dually eligible for Medicare and Medicaid. The rate of reimbursement will be reduced from 100% to 88%, then 76% and then 65% for cost reporting periods beginning on or after October 1, 2012, October 1, 2013, and October 1, 2014, respectively. The rate of reimbursement for patients not dually eligible for both Medicare and Medicaid will be reduced from 70% to 65%, effective with cost reporting periods beginning on or after October 1, 2012. Approximately 90% of the Company’s Medicare bad debt reimbursements are associated with patients that are dually eligible.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Other Information (Continued)

Effects of inflation and changing prices (Continued)

 

On July 27, 2012, CMS issued final regulations updating Medicare payment rates for skilled nursing and rehabilitation centers effective October 1, 2012. These final regulations implement a net market basket increase of 1.8% consisting of (1) a 2.5% market basket inflation increase, less (2) a 0.7% adjustment to account for the effect of a productivity adjustment.

Medicare Part B provides reimbursement for certain physician services, limited drug coverage and other outpatient services, such as therapy and other services, outside of a Medicare Part A covered patient stay. Payment for these services is determined according to the Medicare Physician Fee Schedule (“MPFS”). Annually since 1997, the MPFS has been subject to a sustainable growth rate adjustment (“SGR”), intended to keep spending growth in line with allowable spending. Each year since the SGR was enacted, this adjustment produced a scheduled negative update to payment for physicians, therapists and other healthcare providers paid under the MPFS. Annually, since 2002, Congress has stepped in with so-called “doc fix” legislation to stop payment cuts to physicians. In February 2012, Congress passed the Job Creation Act of 2012 which further suspended the payment cut until December 31, 2012.

Since 2006, federal legislation has provided for an annual Medicare Part B outpatient therapy cap. In succeeding years, CMS subsequently increased the amount of the therapy cap. Legislation also was passed that required CMS to implement a broad process for reviewing medically necessary therapy claims, creating an exception to the cap. Legislation has annually extended the Medicare Part B outpatient therapy cap exception process. The Job Creation Act of 2012 further extended the therapy cap exception process through December 31, 2012. Patients in the Company’s facilities whose stay is not reimbursed by Medicare must seek reimbursement for their therapy under Medicare Part B and are subject to the therapy cap.

Effective January 1, 2011, reimbursement rates for Medicare Part B therapy services included in the MPFS were reduced for secondary procedures when multiple therapy services are provided on the same day. CMS projected that the rule would result in an approximate 7% rate reduction for Medicare Part B therapy services in calendar year 2011. The Company estimated that this rule reduced its Medicare revenues related to Part B therapy services by approximately $7 million in 2011.

On July 24, 2012, CMS issued final regulations regarding Medicare payment rates for hospice providers effective October 1, 2012. These final regulations implement a net market basket increase of 1.6% consisting of: (1) a 2.6% market basket inflation increase, less (2) offsets to the standard payment conversion factor mandated by the ACA of: (a) a 0.7% adjustment to account for the effect of a productivity adjustment, and (b) 0.3% as required by statute. CMS has projected the impact of these changes will result in a 0.9% increase in payments to hospice providers.

The Company believes that its operating margins will continue to be under pressure 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, the Company’s ability to maintain operating margins through price increases to private patients is limited.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Condensed Consolidated Statement of Operations

(Unaudited)

(In thousands, except per share amounts)

 

     2011 Quarters     2012 Quarters  
     First     Second     Third     Fourth     First     Second  

Revenues

   $ 1,192,421      $ 1,292,592      $ 1,514,062      $ 1,522,688      $ 1,579,970      $ 1,535,828   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

     678,695        765,133        900,570        911,417        945,302        907,106   

Supplies

     90,022        96,718        107,514        107,760        111,295        108,238   

Rent

     91,453        95,677        105,511        106,616        107,968        107,541   

Other operating expenses

     259,369        287,132        305,305        312,674        310,964        312,995   

Other income

     (2,785     (2,880     (2,815     (2,711     (2,748     (2,698

Impairment charges

     —          —          26,712        102,569        867        329   

Depreciation and amortization

     32,549        37,871        46,947        48,227        48,690        49,802   

Interest expense

     5,728        23,157        25,790        26,244        26,578        26,716   

Investment income

     (495     (257     (37     (242     (292     (275
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     1,154,536        1,302,551        1,515,497        1,612,554        1,548,624        1,509,754   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     37,885        (9,959     (1,435     (89,866     31,346        26,074   

Provision (benefit) for income taxes

     15,609        (3,419     (2,342     (16,952     12,814        10,797   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     22,276        (6,540     907        (72,914     18,532        15,277   

Income (loss) from discontinued operations, net of income taxes

     (179     587        1,119        1,025        110        (14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     22,097        (5,953     2,026        (71,889     18,642        15,263   

(Earnings) loss attributable to noncontrolling interests

     —          421        (241     58        (451     239   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) attributable to Kindred

   $ 22,097      $ (5,532   $ 1,785      $ (71,831   $ 18,191      $ 15,502   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amounts attributable to Kindred stockholders:

            

Income (loss) from continuing operations

   $ 22,276      $ (6,119   $ 666      $ (72,856   $ 18,081      $ 15,516   

Income (loss) from discontinued operations

     (179     587        1,119        1,025        110        (14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 22,097      $ (5,532   $ 1,785      $ (71,831   $ 18,191      $ 15,502   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per common share:

            

Basic:

            

Income (loss) from continuing operations

   $ 0.56      $ (0.14   $ 0.01      $ (1.42   $ 0.35      $ 0.29   

Income (loss) from discontinued operations

     —          0.01        0.02        0.02        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.56      $ (0.13   $ 0.03      $ (1.40   $ 0.35      $ 0.29   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

            

Income (loss) from continuing operations

   $ 0.55      $ (0.14   $ 0.01      $ (1.42   $ 0.35      $ 0.29   

Income (loss) from discontinued operations

     —          0.01        0.02        0.02        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 0.55      $ (0.13   $ 0.03      $ (1.40   $ 0.35      $ 0.29   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in computing earnings (loss) per common share:

            

Basic

     39,035        43,231        51,329        51,335        51,603        51,664   

Diluted

     39,543        43,231        51,406        51,335        51,638        51,675   

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Operating Data

(Unaudited)

(In thousands)

 

     2011 Quarters     2012 Quarters  
     First     Second     Third     Fourth     First     Second  

Revenues:

            

Hospital division

   $ 558,974      $ 593,425      $ 684,781      $ 712,812      $ 765,823      $ 729,419   

Nursing center division

     567,472        568,199        571,226        547,202        544,319        535,644   

Rehabilitation division:

            

Skilled nursing rehabilitation services

     114,618        161,246        252,574        246,720        255,451        255,187   

Hospital rehabilitation services

     22,490        38,291        69,811        70,232        74,369        73,379   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     137,108        199,537        322,385        316,952        329,820        328,566   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Home health and hospice division

     8,038        10,828        15,419        26,451        28,432        28,872   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     1,271,592        1,371,989        1,593,811        1,603,417        1,668,394        1,622,501   

Eliminations:

            

Skilled nursing rehabilitation services

     (57,081     (57,587     (57,922     (57,087     (58,433     (57,056

Hospital rehabilitation services

     (21,225     (20,706     (20,528     (22,167     (28,317     (27,755

Nursing and rehabilitation centers

     (865     (1,104     (1,299     (1,475     (1,674     (1,862
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (79,171     (79,397     (79,749     (80,729     (88,424     (86,673
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 1,192,421      $ 1,292,592      $ 1,514,062      $ 1,522,688      $ 1,579,970      $ 1,535,828   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations:

            

Operating income (loss):

            

Hospital division

   $ 108,385      $ 108,465      $ 125,701      $ 144,891      $ 160,669      $ 141,511 (a) 

Nursing center division

     87,350        93,532        89,592        67,791        65,533        71,005 (b) 

Rehabilitation division:

            

Skilled nursing rehabilitation services

     9,159        15,978        27,575        13,204        14,193        22,942   

Hospital rehabilitation services

     5,332        8,033        15,606        14,760        16,116        17,860   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     14,491        24,011        43,181        27,964        30,309        40,802   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Home health and hospice division

     (10     (447     1,107        2,453        2,341        2,789   

Corporate:

            

Overhead

     (38,315     (43,801     (48,806     (43,878     (42,728     (44,723

Insurance subsidiary

     (602     (420     (750     (534     (482     (600
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     (38,917     (44,221     (49,556     (44,412     (43,210     (45,323

Impairment charges

     —          —          (26,712     (102,569     (867     (329

Transaction costs

     (4,179     (34,851     (6,537     (5,139     (485     (597
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     167,120        146,489        176,776        90,979        214,290        209,858   

Rent

     (91,453     (95,677     (105,511     (106,616     (107,968     (107,541 )(c) 

Depreciation and amortization

     (32,549     (37,871     (46,947     (48,227     (48,690     (49,802

Interest, net

     (5,233     (22,900     (25,753     (26,002     (26,286     (26,441
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

     37,885        (9,959     (1,435     (89,866     31,346        26,074   

Provision (benefit) for income taxes

     15,609        (3,419     (2,342     (16,952     12,814        10,797   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 22,276      $ (6,540   $ 907      $ (72,914   $ 18,532      $ 15,277   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Includes severance ($0.6 million) and other miscellaneous costs ($2.0 million) incurred in connection with the closing of two LTAC hospitals and the cancellation of a sub-acute unit project, and $5.0 million for employment-related lawsuits.
(b) Includes employee retention costs of $0.7 million incurred in connection with the decision to allow leases to expire for 54 nursing and rehabilitation centers leased from Ventas.
(c) Includes lease cancellation charges of $1.1 million incurred in connection with the closing of two LTAC hospitals.

 

61


Table of Contents

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Operating Data (Continued)

(Unaudited)

(In thousands)

 

     2011 Quarters      2012 Quarters  
     First      Second      Third      Fourth      First      Second  

Rent:

                 

Hospital division

   $ 40,299       $ 43,997       $ 52,737       $ 52,299       $ 55,367       $ 54,719   

Nursing center division

     49,384         49,562         49,862         49,748         49,938         50,229   

Rehabilitation division:

                 

Skilled nursing rehabilitation services

     1,509         1,540         1,811         1,415         1,392         1,359   

Hospital rehabilitation services

     28         33         95         72         78         39   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     1,537         1,573         1,906         1,487         1,470         1,398   

Home health and hospice division

     189         251         358         568         615         609   

Corporate

     44         294         648         2,514         578         586   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 91,453       $ 95,677       $ 105,511       $ 106,616       $ 107,968       $ 107,541   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Depreciation and amortization:

                 

Hospital division

   $ 14,278       $ 16,572       $ 21,612       $ 22,448       $ 22,603       $ 22,866   

Nursing center division

     11,793         13,038         12,655         12,554         12,741         13,229   

Rehabilitation division:

                 

Skilled nursing rehabilitation services

     654         1,221         2,699         2,617         2,628         2,724   

Hospital rehabilitation services

     97         819         2,372         2,349         2,324         2,323   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     751         2,040         5,071         4,966         4,952         5,047   

Home health and hospice division

     105         118         324         902         898         925   

Corporate

     5,622         6,103         7,285         7,357         7,496         7,735   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 32,549       $ 37,871       $ 46,947       $ 48,227       $ 48,690       $ 49,802   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Capital expenditures, excluding acquisitions (including discontinued operations):

                 

Hospital division:

                 

Routine

   $ 12,144       $ 11,809       $ 12,919       $ 9,521       $ 10,345       $ 9,095   

Development

     7,777         6,423         39,964         13,157         9,949         11,289   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     19,921         18,232         52,883         22,678         20,294         20,384   

Nursing center division:

                 

Routine

     8,155         8,000         10,572         7,577         4,229         3,417   

Development

     3,322         7,705         4,113         4,027         673         1,087   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     11,477         15,705         14,685         11,604         4,902         4,504   

Rehabilitation division:

                 

Skilled nursing rehabilitation services:

                 

Routine

     235         179         255         1,031         326         569   

Development

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     235         179         255         1,031         326         569   

Hospital rehabilitation services:

                 

Routine

     25         72         81         60         46         60   

Development

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     25         72         81         60         46         60   

Home health and hospice division:

                 

Routine

     20         38         41         65         124         145   

Development

     10         181         75         901         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     30         219         116         966         124         145   

Corporate:

                 

Information systems

     3,932         13,641         11,516         18,629         6,864         15,195   

Other

     207         211         1,211         757         172         278   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 35,827       $ 48,259       $ 80,747       $ 55,725       $ 32,728       $ 41,135   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

62


Table of Contents

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Condensed Consolidating Statement of Operations

(Unaudited)

(In thousands)

 

    Second Quarter 2012  
                Rehabilitation division                                
    Hospital
division (a,c)
    Nursing
center
division (b)
    Skilled
nursing
services
    Hospital
services
    Total     Home health
and hospice
division
    Corporate     Transaction-
related
costs
    Eliminations     Consolidated  

Revenues

  $ 729,419      $ 535,644      $ 255,187      $ 73,379      $ 328,566      $ 28,872      $ —        $ —        $ (86,673   $ 1,535,828   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

    321,088        258,633        224,472        50,949        275,421        21,206        30,796        —          (38     907,106   

Supplies

    79,431        26,616        729        40        769        1,236        186        —          —          108,238   

Rent

    54,719        50,229        1,359        39        1,398        609        586        —          —          107,541   

Other operating expenses

    187,389        179,390        7,044        4,530        11,574        3,641        17,039        597        (86,635     312,995   

Other income

    —          —          —          —          —          —          (2,698     —          —          (2,698

Impairment charges

    47        282        —          —          —          —          —          —          —          329   

Depreciation and amortization

    22,866        13,229        2,724        2,323        5,047        925        7,735        —          —          49,802   

Interest expense

    273        20        —          —          —          —          26,423        —          —          26,716   

Investment income

    (35     (28     —          —          —          —          (212     —          —          (275
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    665,778        528,371        236,328        57,881        294,209        27,617        79,855        597        (86,673     1,509,754   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

  $ 63,641      $ 7,273      $ 18,859      $ 15,498      $ 34,357      $ 1,255      $ (79,855   $ (597   $ —          26,074   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Provision for income taxes

                      10,797   
                   

 

 

 

Income from continuing operations

                    $ 15,277   
                   

 

 

 

 

    Second Quarter 2011  
                Rehabilitation division                                
    Hospital
division
    Nursing
center
division
    Skilled
nursing
services
    Hospital
services
    Total     Home health
and hospice
division
    Corporate     Transaction-
related
costs
    Eliminations     Consolidated  

Revenues

  $ 593,425      $ 568,199      $ 161,246      $ 38,291      $ 199,537      $ 10,828      $ —        $ —        $ (79,397   $ 1,292,592   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

    273,260        270,347        139,998        28,062        168,060        8,262        30,354        14,866        (16     765,133   

Supplies

    67,612        27,870        614        38        652        391        193        —          —          96,718   

Rent

    43,997        49,562        1,540        33        1,573        251        294        —          —          95,677   

Other operating expenses

    144,088        176,450        4,656        2,158        6,814        2,622        16,554        19,985        (79,381     287,132   

Other income

    —          —          —          —          —          —          (2,880     —          —          (2,880

Depreciation and amortization

    16,572        13,038        1,221        819        2,040        118        6,103        —          —          37,871   

Interest expense

    66        22        —          —          —          —          11,266        11,803        —          23,157   

Investment income

    (2     (20     (1     —          (1     —          (234     —          —          (257
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    545,593        537,269        148,028        31,110        179,138        11,644        61,650        46,654        (79,397     1,302,551   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

  $ 47,832      $ 30,930      $ 13,218      $ 7,181      $ 20,399      $ (816   $ (61,650   $ (46,654   $ —          (9,959
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Income tax benefit

                      (3,419
                   

 

 

 

Loss from continuing operations

                    $ (6,540
                   

 

 

 

 

(a) Includes severance ($0.6 million) and other miscellaneous costs ($2.0 million) incurred in connection with the closing of two LTAC hospitals and the cancellation of a sub-acute unit project, and $5.0 million for employment-related lawsuits.
(b) Includes employee retention costs of $0.7 million incurred in connection with the decision to allow leases to expire for 54 nursing and rehabilitation centers leased from Ventas.
(c) Includes lease cancellation charges of $1.1 million incurred in connection with the closing of two LTAC hospitals.

 

63


Table of Contents

ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Condensed Consolidating Statement of Operations (Continued)

(Unaudited)

(In thousands)

 

    Six months ended June 30, 2012  
                Rehabilitation division                                
    Hospital
division (a,c)
    Nursing
center
division (b)
    Skilled
nursing
services
    Hospital
services
    Total     Home health
and hospice
division
    Corporate     Transaction-
related
costs
    Eliminations     Consolidated  

Revenues

  $ 1,495,242      $ 1,079,963      $ 510,638      $ 147,748      $ 658,386      $ 57,304      $ —        $ —        $ (175,097   $ 3,115,798   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

    660,244        527,671        456,610        104,680        561,290        42,497        60,775        —          (69     1,852,408   

Supplies

    161,907        53,340        1,528        94        1,622        2,269        395        —          —          219,533   

Rent

    110,086        100,167        2,751        117        2,868        1,224        1,164        —          —          215,509   

Other operating expenses

    370,911        362,414        15,365        8,998        24,363        7,408        32,809        1,082        (175,028     623,959   

Other income

    —          —          —          —          —          —          (5,446     —          —          (5,446

Impairment charges

    351        845        —          —          —          —          —          —          —          1,196   

Depreciation and amortization

    45,469        25,970        5,352        4,647        9,999        1,823        15,231        —          —          98,492   

Interest expense

    579        48        —          —          —          —          52,667        —          —          53,294   

Investment income

    (43     (46     (1     —          (1     —          (477     —          —          (567
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    1,349,504        1,070,409        481,605        118,536        600,141        55,221        157,118        1,082        (175,097     3,058,378   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

  $ 145,738      $ 9,554      $ 29,033      $ 29,212      $ 58,245      $ 2,083      $ (157,118   $ (1,082   $ —          57,420   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Provision for income taxes

                      23,611   
                   

 

 

 

Income from continuing operations

                    $ 33,809   
                   

 

 

 

 

    Six months ended June 30, 2011  
                Rehabilitation division                                
    Hospital
division
    Nursing
center
division
    Skilled
nursing
services
    Hospital
services
    Total     Home health
and hospice
division
    Corporate     Transaction-
related
costs
    Eliminations     Consolidated  

Revenues

  $ 1,152,399      $ 1,135,671      $ 275,864      $ 60,781      $ 336,645      $ 18,866      $ —        $ —        $ (158,568   $ 2,485,013   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Salaries, wages and benefits

    526,322        543,517        241,884        44,699        286,583        14,570        58,020        14,866        (50     1,443,828   

Supplies

    129,459        54,995        1,125        64        1,189        761        336        —          —          186,740   

Rent

    84,296        98,946        3,049        61        3,110        440        338        —          —          187,130   

Other operating expenses

    279,768        356,277        7,718        2,653        10,371        3,992        30,447        24,164        (158,518     546,501   

Other income

    —          —          —          —          —          —          (5,665     —          —          (5,665

Depreciation and amortization

    30,850        24,831        1,875        916        2,791        223        11,725        —          —          70,420   

Interest expense

    66        51        —          —          —          —          14,966        13,802        —          28,885   

Investment income

    (3     (40     (2     —          (2     —          (707     —          —          (752
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    1,050,758        1,078,577        255,649        48,393        304,042        19,986        109,460        52,832        (158,568     2,457,087   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income taxes

  $ 101,641      $ 57,094      $ 20,215      $ 12,388      $ 32,603      $ (1,120   $ (109,460   $ (52,832   $ —          27,926   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Provision for income taxes

                      12,190   
                   

 

 

 

Income from continuing operations

                    $ 15,736   
                   

 

 

 

 

(a) Includes severance ($2.6 million) and other miscellaneous costs ($2.3 million) incurred in connection with the closing of a regional office and three LTAC hospitals and the cancellation of a sub-acute unit project, and $5.0 million for employment-related lawsuits.
(b) Includes employee retention costs of $0.7 million incurred in connection with the decision to allow leases to expire for 54 nursing and rehabilitation centers leased from Ventas.
(c) Includes lease cancellation charges of $2.9 million incurred in connection with the closing of three LTAC hospitals.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Operating Data

(Unaudited)

 

     2011 Quarters      2012 Quarters  
     First      Second      Third      Fourth      First      Second  

Hospital division data:

                 

End of period data:

                 

Number of hospitals:

                 

Long-term acute care

     89         120         120         121         120         118   

Inpatient rehabilitation

     —           5         5         5         6         6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     89         125         125         126         126         124   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Number of licensed beds:

                 

Long-term acute care

     6,889         8,609         8,597         8,597         8,510         8,448   

Inpatient rehabilitation

     —           183         183         183         229         259   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     6,889         8,792         8,780         8,780         8,739         8,707   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Revenue mix %:

                 

Medicare

     60         60         60         62         62         61   

Medicaid

     8         8         8         7         6         6   

Medicare Advantage

     10         10         10         10         10         11   

Commercial insurance and other

     22         22         22         21         22         22   

Admissions:

                 

Medicare

     8,504         8,913         11,002         11,682         12,400         11,544   

Medicaid

     1,085         1,163         1,236         1,163         1,025         1,038   

Medicare Advantage

     1,172         1,348         1,609         1,549         1,782         1,970   

Commercial insurance and other

     2,282         2,290         2,669         2,853         3,081         2,770   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     13,043         13,714         16,516         17,247         18,288         17,322   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Admissions mix %:

                 

Medicare

     65         65         67         68         68         67   

Medicaid

     8         8         7         7         5         6   

Medicare Advantage

     9         10         10         9         10         11   

Commercial insurance and other

     18         17         16         16         17         16   

Patient days:

                 

Medicare

     219,213         237,257         275,561         285,358         304,795         290,273   

Medicaid

     45,650         45,746         48,911         48,648         45,058         43,174   

Medicare Advantage

     35,639         39,503         47,819         47,738         51,129         53,822   

Commercial insurance and other

     70,522         72,759         83,375         84,677         89,305         85,645   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     371,024         395,265         455,666         466,421         490,287         472,914   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Average length of stay:

                 

Medicare

     25.8         26.6         25.0         24.4         24.6         25.1   

Medicaid

     42.1         39.3         39.6         41.8         44.0         41.6   

Medicare Advantage

     30.4         29.3         29.7         30.8         28.7         27.3   

Commercial insurance and other

     30.9         31.8         31.2         29.7         29.0         30.9   

Weighted average

     28.4         28.8         27.6         27.0         26.8         27.3   

Revenues per admission:

                 

Medicare

   $ 39,439       $ 40,089       $ 37,408       $ 37,643       $ 38,491       $ 38,716   

Medicaid

     42,432         41,576         40,720         44,618         45,868         44,470   

Medicare Advantage

     46,217         42,708         43,616         46,154         42,632         39,541   

Commercial insurance and other

     54,065         56,850         57,216         52,465         53,733         57,194   

Weighted average

     42,856         43,271         41,462         41,330         41,876         42,109   

Revenues per patient day:

                 

Medicare

   $ 1,530       $ 1,506       $ 1,494       $ 1,541       $ 1,566       $ 1,540   

Medicaid

     1,009         1,057         1,029         1,067         1,043         1,069   

Medicare Advantage

     1,520         1,457         1,468         1,498         1,486         1,447   

Commercial insurance and other

     1,749         1,789         1,832         1,768         1,854         1,850   

Weighted average

     1,507         1,501         1,503         1,528         1,562         1,542   

Medicare case mix index (discharged patients only)

     1.21         1.22         1.17         1.14         1.17         1.17   

Average daily census

     4,122         4,344         4,953         5,070         5,388         5,197   

Occupancy %

     68.7         65.5         62.6         63.5         67.4         64.8   

Annualized employee turnover %

     21.2         22.1         21.4         20.3         21.8         22.2   

 

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Operating Data (Continued)

(Unaudited)

 

     2011 Quarters      2012 Quarters  
     First      Second      Third      Fourth      First      Second  

Nursing center division data:

                 

End of period data:

                 

Number of facilities:

                 

Nursing and rehabilitation centers:

                 

Owned or leased

     220         220         220         220         220         220   

Managed

     4         4         4         4         4         4   

Assisted living facilities

     6         6         6         6         6         6   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     230         230         230         230         230         230   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Number of licensed beds:

                 

Nursing and rehabilitation centers:

                 

Owned or leased

     26,767         26,687         26,687         26,663         26,663         26,711   

Managed

     485         485         485         485         485         485   

Assisted living facilities

     413         413         413         413         413         341   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     27,665         27,585         27,585         27,561         27,561         27,537   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Revenue mix %:

                 

Medicare

     38         37         36         33         34         33   

Medicaid

     37         38         38         40         39         41   

Medicare Advantage

     7         7         7         7         8         7   

Private and other

     18         18         19         20         19         19   

Patient days (a):

                 

Medicare

     370,395         358,760         345,362         334,156         342,567         328,011   

Medicaid

     1,232,620         1,229,517         1,255,418         1,248,442         1,218,903         1,215,623   

Medicare Advantage

     97,460         94,483         95,751         95,730         101,312         97,583   

Private and other

     425,414         435,667         436,074         441,362         422,983         412,403   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     2,125,889         2,118,427         2,132,605         2,119,690         2,085,765         2,053,620   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Patient day mix % (a):

                 

Medicare

     17         17         16         16         16         16   

Medicaid

     58         58         59         59         59         59   

Medicare Advantage

     5         4         5         4         5         5   

Private and other

     20         21         20         21         20         20   

Revenues per patient day (a):

                 

Medicare Part A

   $ 537       $ 544       $ 550       $ 491       $ 484       $ 483   

Total Medicare (including Part B)

     579         589         599         544         536         538   

Medicaid

     172         173         174         176         176         178   

Medicaid (net of provider taxes) (b)

     155         156         155         156         156         158   

Medicare Advantage

     416         420         421         405         407         405   

Private and other

     235         240         243         241         248         250   

Weighted average

     267         268         268         258         261         261   

Average daily census (a)

     23,621         23,279         23,180         23,040         22,920         22,567   

Admissions (a)

     20,619         20,143         20,118         19,914         20,863         19,593   

Occupancy % (a)

     86.9         85.9         85.5         85.1         84.7         83.5   

Medicare average length of stay (a)

     32.9         33.4         33.0         32.1         31.8         32.2   

Annualized employee turnover %

     37.8         39.8         40.2         39.2         36.9         39.2   

 

(a) Excludes managed facilities.
(b) Provider taxes are recorded in other operating expenses for all periods presented.

 

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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (Continued)

 

Operating Data (Continued)

(Unaudited)

 

     2011 Quarters      2012 Quarters  
     First      Second      Third      Fourth      First      Second  

Rehabilitation division data:

                 

Skilled nursing rehabilitation services:

                 

Revenue mix %:

                 

Company-operated

     50         36         23         23         23         22   

Non-affiliated

     50         64         77         77         77         78   

Sites of service (at end of period)

     641         1,848         1,835         1,774         1,722         1,730   

Revenue per site

   $ 178,812       $ 137,316       $ 137,643       $ 139,077       $ 148,346       $ 147,507   

Therapist productivity %

     80.6         81.6         80.5         80.1         80.3         80.4   

Hospital rehabilitation services:

                 

Revenue mix %:

                 

Company-operated

     94         54         29         32         38         38   

Non-affiliated

     6         46         71         68         62         62   

Sites of services (at end of period):

                 

Inpatient rehabilitation units

     1         104         102         102         100         102   

LTAC hospitals

     93         97         99         115         125         125   

Sub-acute units

     8         22         23         25         19         20   

Outpatient units

     12         119         114         115         111         115   

Other

     5         8         7         8         5         5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     119         350         345         365         360         367   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Revenue per site

   $ 188,989       $ 199,661       $ 202,352       $ 192,410       $ 206,580       $ 199,943   

Annualized employee turnover %

     14.5         17.1         16.5         16.5         19.6         16.9   

 

 

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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion of the Company’s exposure to market risk contains “forward-looking statements” that involve risks and uncertainties. Given the unpredictability of interest rates as well as other factors, actual results could differ materially from those projected in such forward-looking information.

The Company’s exposure to market risk relates to changes in the prime rate, federal funds rate and LIBOR which affect the interest paid on certain borrowings.

The following table provides information about the Company’s financial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by expected maturity date.

Interest Rate Sensitivity

Principal (Notional) Amount by Expected Maturity

Average Interest Rate

(Dollars in thousands)

 

     Expected maturities      Fair
value
6/30/12
 
     2012     2013     2014     2015     2016     Thereafter     Total     

Liabilities:

                 

Long-term debt, including amounts due within one year:

                 

Fixed rate:

                 

Notes

   $ —        $ —        $ —        $ —        $ —        $ 550,000      $ 550,000       $ 521,400   

Other

     49        102        109        116        123        10        509         491 (a) 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
   $ 49      $ 102      $ 109      $ 116      $ 123      $ 550,010      $ 550,509       $ 521,891   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Average interest rate

     6.0     6.0     6.0     6.0     6.0     8.2     

Variable rate:

                 

ABL Facility (b)

   $ —        $ —        $ —        $ —        $ 403,700      $ —        $ 403,700       $ 403,700   

Term Loan Facility (c,d)

     3,500        7,000        7,000        7,000        7,000        661,500        693,000         656,895   

Other (e)

     115        233        233        3,720        —          —          4,301         4,301   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
   $ 3,615      $ 7,233      $ 7,233      $ 10,720      $ 410,700      $ 661,500      $ 1,101,001       $ 1,064,896   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(a) Calculated based upon the net present value of future principal and interest payments using a discount rate of 6%.
(b) Interest on borrowings under the Company’s ABL Facility is payable, at the Company’s option, at a rate per annum equal to the applicable margin plus, at the Company’s option, either (1) LIBOR determined by reference to the costs of funds for eurodollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, or (2) a base rate determined by reference to the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the federal funds effective rate plus one-half of 1.00% and (c) LIBOR as described in subclause (1) plus 1.00%. At June 30, 2012, the applicable margin for borrowings under the ABL Facility was 2.75% with respect to LIBOR borrowings and 1.75% with respect to base rate borrowings. The applicable margin is subject to adjustment each fiscal quarter, based upon average historical excess availability during the preceding quarter.
(c) Interest on borrowings under the Term Loan Facility is payable, at the Company’s option, at a rate per annum equal to an applicable margin plus, at the Company’s option, either (1) LIBOR determined by reference to the costs of funds for eurodollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, or (2) a base rate determined by reference to the highest of (a) the prime rate of JPMorgan Chase Bank, N.A., (b) the federal funds effective rate plus one-half of 1.00% and (c) LIBOR described in subclause (1) plus 1.00%. LIBOR is subject to an interest rate floor of 1.50%. The applicable margin for borrowings under the Term Loan Facility is 3.75% with respect to LIBOR borrowings and 2.75% with respect to base rate borrowings. The expected maturities for the Term Loan Facility exclude the original issue discount of approximately $6 million.
(d) In December 2011, the Company entered into two interest rate swap agreements to hedge its floating interest rate on an aggregate of $225 million of outstanding Term Loan Facility debt. The interest rate swaps have an effective date of January 9, 2012, and expire on January 11, 2016. The Company is required to make payments based upon a fixed interest rate of 1.8925% calculated on the notional amount of $225 million. In exchange, the Company will receive interest on $225 million at a variable interest rate that is based upon the three-month LIBOR, subject to a minimum rate of 1.5%.
(e) Interest based upon LIBOR plus 4%.

 

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ITEM 4.    CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures and Changes in Internal Control Over Financial Reporting

The Company has carried out an evaluation under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’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 this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2012, the Company’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.

There has been no change in the Company’s internal control over financial reporting during the Company’s quarter ended June 30, 2012, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

The Company is a party to various legal actions (some of which are not insured), and regulatory and other governmental audits and investigations in the ordinary course of business. The Company cannot predict the ultimate outcome of pending litigation and regulatory and other governmental audits and investigations. These matters could potentially subject the Company to sanctions, damages, recoupments, fines and other penalties. The DOJ, CMS or other federal and state enforcement and regulatory agencies may conduct additional investigations related to the Company’s businesses in the future which may, either individually or in the aggregate, have a material adverse effect on the Company’s business, financial position, results of operations and liquidity. See Note 14 of the notes to condensed consolidated financial statements for a description of the Company’s other pending legal proceedings.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

  Total number of
shares (or units)
purchased (a)
     Average price
paid per share
(or unit) (b)
     Total number of
shares (or units)
purchased as part of
publicly announced
plans or programs
     Maximum number (or
approximate dollar value)
of shares (or  units) that may
yet be purchased under the
plans or programs (a)
 

Month #1 (April 1 — April 30)

    —         $ —           —         $ —     

Month #2 (May 1 — May 31)

    290         8.27         —           —     

Month #3 (June 1 — June 30)

    2,669         8.48         —           —     
 

 

 

       

 

 

    

Total

    2,959       $ 8.46         —         $ —     
 

 

 

       

 

 

    

 

(a) These amounts represent shares of the Company’s common stock, par value $0.25 per share, withheld to offset tax withholding obligations that occurred upon the vesting and release of service-based restricted share awards previously granted under the Company’s stock-based compensation plans for its employees (the “Withheld Shares”). For each employee, the total tax withholding obligation is divided by the closing price of the Company’s common stock on the New York Stock Exchange on the applicable vesting date to determine the total number of Withheld Shares required to satisfy such withholding obligation.
(b) The average price per share for each period was calculated by dividing the sum of the aggregate value of the Withheld Shares by the total number of Withheld Shares.

 

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PART II. OTHER INFORMATION (Continued)

 

Item 6. Exhibits

 

10.1    2012 Equity Plan for Non-Employee Directors. Appendix A to the Company’s Proxy Statement on Schedule 14A dated April 3, 2012 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.2    Notice of Renewal of Renewal Group 1 dated as of April 26, 2012 under that Second Amended and Restated Master Lease Agreement No. 2.
10.3    Notice of Renewal of Renewal Group 1 dated as of April 26, 2012 under that Second Amended and Restated Master Lease Agreement No. 4.
10.4    Employment Agreement dated as of May 17, 2012 by and between Kindred Healthcare Operating, Inc. and Paul J. Diaz.
10.5    Employment Agreement dated as of May 17, 2012 by and between Kindred Healthcare Operating, Inc. and Benjamin A. Breier.
10.6    Employment Agreement dated as of May 17, 2012 by and between Kindred Healthcare Operating, Inc. and William M. Altman.
10.7    Employment Agreement dated as of May 17, 2012 by and between Kindred Healthcare Operating, Inc. and Gregory C. Miller.
10.8    Employment Agreement dated as of May 17, 2012 by and between Kindred Healthcare Operating, Inc. and Joseph L. Landenwich.
10.9    Master Lease Agreement No. 5 dated as of May 23, 2012 executed by Ventas Realty, Limited Partnership, as Lessor and Kindred Healthcare, Inc. and Kindred Healthcare Operating, Inc., as Tenant. Exhibit 10.1 to the Company’s Current Report on Form 8-K dated May 23, 2012 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.10    Side Letter dated as of May 23, 2012 to the Second Amended and Restated Master Lease Agreement
Nos. 1, 2, 3 and 4.
31    Rule 13a-14(a)/15d-14(a) Certifications.
32    Section 1350 Certifications.
101.INS    XBRL Instance Document. *
101.SCH    XBRL Taxonomy Extension Schema Document. *
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document. *
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document. *
101.LAB    XBRL Taxonomy Extension Label Linkbase Document. *
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document. *

 

* In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed.”

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   KINDRED HEALTHCARE, INC.

Date: August 8, 2012

  

/s/    PAUL J. DIAZ        

     Paul J. Diaz
     Chief Executive Officer

Date: August 8, 2012

  

/s/    RICHARD A. LECHLEITER        

     Richard A. Lechleiter
    

Executive Vice President and

Chief Financial Officer

 

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