--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------
FORM 10-K/A
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-14057
----------------
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc.)
(Exact name of registrant as specified in its charter)
Delaware 61-1323993
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
680 South Fourth Street
Louisville, Kentucky 40202-2412
(Address of principal executive offices) (Zip Code)
(502) 596-7300
(Registrant's telephone number, including area code)
----------------
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
------------------- ---------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.25 per share
----------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment of this Form 10-K. [X]
As of February 28, 2001, there were 70,233,280 shares of the Registrant's
common stock, $0.25 par value, outstanding. The aggregate market value of the
shares of the Registrant held by non-affiliates of the Registrant, based on the
closing price of such stock on the OTC Bulletin Board on February 28, 2001, was
approximately $2,780,000. For purposes of the foregoing calculation only, all
directors and executive officers of the Registrant have been deemed affiliates.
DOCUMENTS INCORPORATED BY REFERENCE
None
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business...................................................... 3
Item 2. Properties.................................................... 43
Item 3. Legal Proceedings............................................. 43
Item 4. Submission of Matters to a Vote of Security Holders........... 49
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 50
Item 6. Selected Financial Data....................................... 51
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 52
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 67
Item 8. Financial Statements and Supplementary Data................... 68
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure...................................... 68
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K........................................................... 70
2
INTRODUCTION
On August 14, 2001, the Company announced that it will restate certain of its
previously issued consolidated financial statements. The Company recently
determined that an oversight related to the allowance for professional
liability risks had occurred in its consolidated financial statements beginning
in 1998. The oversight resulted in the understatement of the provision for
professional liability claims in 1998, 1999 and 2000 because the Company did
not record a reserve for claims incurred but not reported at the respective
balance sheet dates. See Note 2 of the Notes to Consolidated Financial
Statements for a description of the restatement and its effect on the Company's
previously issued consolidated financial statements for 1998, 1999 and 2000.
In addition, the Company revised its disclosure of future minimum lease
payments under non-cancelable operating leases to exclude contingent rentals.
See Note 12 of the Notes to Consolidated Financial Statements.
This Annual Report on Form 10-K/A amends the Company's previously filed
Annual Report on Form 10-K for the year ended December 31, 2000. Consolidated
financial statement information and related disclosures included in this
amended filing reflect, where appropriate, changes resulting from the
restatement.
PART I
Item 1. Business
GENERAL
Kindred Healthcare, Inc. ("Kindred" or the "Company") (formerly Vencor, Inc.
until April 20, 2001) provides long-term healthcare services primarily through
the operation of nursing centers and hospitals. At December 31, 2000, the
Company's health services division operated 312 nursing centers (40,189
licensed beds) in 31 states and a rehabilitation therapy business. The
Company's hospital division operated 56 hospitals (4,886 licensed beds) in 23
states and an institutional pharmacy business.
The Company and substantially all of its subsidiaries filed voluntary
petitions for protection under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code") on September 13, 1999. The Company currently is
operating its businesses as a debtor-in-possession subject to the jurisdiction
of the United States Bankruptcy Court in Delaware (the "Bankruptcy Court"). See
"--Proceedings under Chapter 11 of the Bankruptcy Code."
On May 1, 1998, Ventas, Inc. ("Ventas" or the "Company's predecessor")
completed the spin-off of its healthcare operations to its stockholders through
the distribution of the Company's common stock (the "Spin-off"). Ventas
retained ownership of substantially all of its real property and leases such
real property to the Company under four master lease agreements. In
anticipation of the Spin-off, the Company was incorporated on March 27, 1998 as
a Delaware corporation. For accounting purposes, the consolidated historical
financial statements of Ventas became the Company's historical financial
statements following the Spin-off. Any discussion concerning events prior to
May 1, 1998 refers to the Company's business as it was conducted by Ventas
prior to the Spin-off.
On September 28, 1995, The Hillhaven Corporation ("Hillhaven") merged into
the Company. On March 21, 1997, the Company acquired TheraTx, Incorporated
("TheraTx"), a provider of rehabilitation and respiratory therapy program
management services to nursing centers and an operator of 26 nursing centers.
On June 24, 1997, the Company acquired a controlling interest in Transitional
Hospitals Corporation ("Transitional"), an operator of 19 long-term acute care
hospitals located in 13 states. The Company completed the merger of its wholly
owned subsidiary into Transitional on August 26, 1997.
3
This Annual Report on Form 10-K/A includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). See "--Cautionary Statements."
Proceedings under Chapter 11 of the Bankruptcy Code
On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 cases have been consolidated for purposes of joint
administration under Case Nos. 99-3199 (MFW) through 99-3327 (MFW)
(collectively, the "Chapter 11 Cases").
On March 1, 2001, the Bankruptcy Court approved the Company's fourth amended
plan of reorganization filed with the Bankruptcy Court on December 14, 2000, as
modified at the confirmation hearing (the "Amended Plan"). The order confirming
the Amended Plan was entered on March 16, 2001. The Company is proceeding
expeditiously to implement the Amended Plan which, under the terms of the
Amended Plan, must be effective no later than May 1, 2001.
In connection with the confirmation hearing, the Company entered into a
commitment letter for a $120 million senior exit facility with a lending group
led by Morgan Guaranty Trust Company of New York (the "Exit Facility"). The
Exit Facility will be available to fund the Company's obligations under the
Amended Plan and its ongoing operations following emergence from bankruptcy.
The consummation of the Amended Plan is subject to a number of material
conditions including, without limitation, the negotiation and execution of
definitive agreements for the Exit Facility. There can be no assurance that the
Amended Plan will be consummated.
Amended Plan of Reorganization
The Amended Plan represents a consensual arrangement among Ventas, the
Company's senior bank lenders (the "Senior Lenders"), holders of the Company's
$300 million 9 7/8% Guaranteed Senior Subordinated Notes due 2005 (the "1998
Notes"), the United States Department of Justice (the "DOJ"), acting on behalf
of the Department of Health and Human Services' Office of the Inspector General
(the "OIG") and the Health Care Financing Administration ("HCFA")
(collectively, the "Government") and the advisors to the official committee of
unsecured creditors.
The Company distributed its disclosure materials soliciting approval of the
Amended Plan on December 29, 2000. Voting on the Amended Plan concluded on
February 15, 2001 (other than for Ventas, which voted prior to the confirmation
hearing) and the Company received the requisite acceptances from various
creditor classes to confirm the Amended Plan.
The following is a summary of certain material provisions of the Amended
Plan. The summary does not purport to be complete and is qualified in its
entirety by reference to all of the provisions of the Amended Plan, including
all exhibits and documents described therein, as filed with the Bankruptcy
Court and as may otherwise be amended, modified or supplemented.
The Amended Plan provides for, among other things, the following
distributions:
Senior Lender Claims--The Senior Lenders will receive, in the aggregate, new
senior subordinated secured notes in the principal amount of $300 million,
bearing interest at the rate of LIBOR plus 4 1/2%, with a maturity of seven
years (the "New Senior Secured Notes"). The interest on the New Senior Secured
Notes will begin to accrue approximately two quarters following the effective
date of the Amended Plan and, in lieu of interest payments, the Company will
pay a $25.9 million obligation under the Government Settlement (as defined)
within the first two full fiscal quarters following the effective date of the
Amended Plan as described below. In addition, holders of the Senior Lender
claims will receive an aggregate distribution of 65.51% of the
4
new common stock (the "New Common Stock") of the reorganized Company (subject
to dilution from stock issuances occurring after the effective date of the
Amended Plan).
Senior Subordinated Noteholder Claims--The holders of the 1998 Notes and the
remaining $2.4 million of the Company's 8 5/8% Senior Subordinated Notes due
2007 (collectively, the "Subordinated Noteholder Claims") will receive, in the
aggregate, 24.50% of the New Common Stock (subject to dilution from stock
issuances occurring after the effective date of the Amended Plan). In addition,
the holders of the Subordinated Noteholder Claims will receive, in the
aggregate, warrants issued by the Company for the purchase of an aggregate of
7,000,000 shares of New Common Stock, with a five-year term, which will consist
of warrants to purchase 2,000,000 shares at a price per share of $30.00, and
warrants to purchase 5,000,000 shares at a price per share of $33.33.
Ventas Claim--Ventas will receive the following treatment under the Amended
Plan:
The four master leases and the Corydon Lease (as defined) with Ventas will be
assumed and simultaneously amended and restated as of the effective date of the
Amended Plan (the "Amended Leases"). The principal economic terms of the
Amended Leases are as follows:
(1) A decrease of $52 million in the aggregate minimum rent from the
annual rent as of May 1, 1999 to a new initial aggregate minimum rent of
$174.6 million as of the first month after the effective date of the
Amended Plan.
(2) Annual aggregate minimum rent payable in cash will escalate at an
annual rate of 3.5% over the prior period annual aggregate minimum rent for
the period from May 1, 2001 through April 30, 2004. Thereafter, annual
aggregate minimum rent payable in cash will escalate at an annual rate of
2%, plus an additional annual accrued escalator amount of 1.5% of the prior
period annual aggregate minimum rent which will accrete from year to year
(with an interest accrual at LIBOR plus 4 1/2%). All accrued rent will be
payable upon the repayment or refinancing of the New Senior Secured Notes,
after which the annual aggregate minimum rent payable in cash will escalate
at an annual rate of 3.5% and there will be no further accrual feature.
(3) A one-time option, that can be exercised by Ventas 5 1/4 years after
the effective date of the Amended Plan, to reset the annual aggregate
minimum rent under one or more of the Amended Leases to the then current
fair market rental in exchange for a payment of $5 million (or a pro rata
portion thereof if fewer than all of the Amended Leases are reset) to the
Company.
(4) Under the Amended Leases, the "Event of Default" provisions also will
be substantially modified and will provide Ventas with more flexibility in
exercising remedies for events of default.
In addition to the Amended Leases, Ventas will receive a distribution of
9.99% of the New Common Stock (subject to dilution from stock issuances
occurring after the effective date of the Amended Plan).
Ventas also will enter into a tax escrow agreement with the Company as of the
effective date that will provide for the escrow of approximately $30 million of
federal, state and local refunds until the expiration of the applicable
statutes of limitation for the auditing of the refund applications. The
escrowed funds will be available for the payment of certain tax deficiencies
during the escrow period except that all interest paid by the government in
connection with any refund or earned on the escrowed funds will be distributed
equally to the parties. At the end of the escrow period, the Company and Ventas
will each be entitled to 50% of any proceeds remaining in the escrow account.
All agreements and indemnification obligations between the Company and
Ventas, except those modified by the Amended Plan, will be assumed by the
Company as of the effective date of the Amended Plan.
5
United States Claims--The claims of the Government (other than claims of the
Internal Revenue Service and criminal claims, if any) will be settled through a
government settlement with the Company and Ventas which will be effectuated
through the Amended Plan (the "Government Settlement").
Under the Government Settlement, the Company will pay the Government a total
of $25.9 million, which will be paid as follows:
(1) $10 million on the effective date of the Amended Plan, and
(2) an aggregate of $15.9 million during the first two full fiscal
quarters following the effective date, plus accrued interest at the rate of
6% per annum beginning as of the effective date of the Amended Plan.
Under the Government Settlement, Ventas will pay the Government a total of
$103.6 million, which will be paid as follows:
(1) $34 million on the effective date of the Amended Plan, and
(2) the remainder paid over five years, bearing interest at the rate of
6% per annum beginning as of the effective date of the Amended Plan.
In addition, the Company will repay the remaining balance of the obligations
under the HCFA Agreement (as defined) (approximately $63.4 million as of
December 31, 2000) pursuant to the terms previously agreed to by the Company.
See "--Events Leading to Reorganization." As previously announced, the Company
has entered into a Corporate Integrity Agreement with the OIG as part of the
overall Government Settlement. See "--Corporate Integrity Agreement." The
Government Settlement also provides for the dismissal of certain pending claims
and lawsuits filed against the Company. See "Legal Proceedings."
General Unsecured Creditors Claims--The general unsecured creditors of the
Company will be paid the full amount of their allowed claims existing as of the
date of the Company's filing for protection under the Bankruptcy Code. These
amounts will be paid in equal quarterly installments over three years beginning
at the end of the first full fiscal quarter following the effective date. The
Company will pay interest on these claims at the rate of 6% per annum from the
effective date of the Amended Plan, subject to certain exceptions. A
convenience class of unsecured creditors, consisting of creditors holding
allowed claims in an amount less than or equal to $3,000, will be paid in full
within 30 days of the effective date of the Amended Plan.
Preferred Stockholder and Common Stockholder Claims--The holders of preferred
stock and common stock of the Company will not receive any distributions under
the Amended Plan. The preferred stock and common stock will be canceled on the
effective date of the Amended Plan.
Other Significant Provisions--The board of directors of the reorganized
Company will consist of: Edward L. Kuntz, the current Chairman of the Board of
Directors, Jeff Altman of Franklin Mutual Advisors, L.L.C., James Bolin of
Appaloosa Management, L.P., Garry N. Garrison, Isaac Kaufman of Advanced
Medical Management, Inc., John H. Klein of BI-Logix, Inc. and David Tepper of
Appaloosa Management, L.P.
A restricted share plan was approved under the Amended Plan that provides for
the issuance of 600,000 shares of New Common Stock to certain key employees of
the Company. The restricted shares will be non-transferable and subject to
forfeiture until they have vested generally over a four-year period. In
addition, a new stock option plan was approved under the Amended Plan for the
issuance of stock options for up to 600,000 shares of New Common Stock to
certain key employees of the Company. The Amended Plan also approves the
Vencor, Inc. 2000 Long-Term Incentive Plan that provides cash bonus awards to
certain key employees on the attainment by the Company of specified performance
goals. See "Executive Compensation." The Amended Plan also provides for the
continuation of the Company's current management retention plan for its
employees and the payment of certain performance bonuses upon the effective
date of the Amended Plan.
6
Debtor-in-Possession Financing Agreement
In connection with the Chapter 11 Cases, the Company entered into a $100
million debtor-in-possession financing agreement (the "DIP Financing"). The
Bankruptcy Court granted final approval of the DIP Financing on October 1,
1999. The DIP Financing was initially comprised of a $75 million tranche A
revolving loan (the "Tranche A Loan") and a $25 million tranche B revolving
loan (the "Tranche B Loan"). Interest is payable at prime plus 2 1/2% on the
Tranche A Loan and prime plus 4 1/2% on the Tranche B Loan.
Available aggregate borrowings under the Tranche A Loan were initially
limited to $45 million in September 1999 and increased to $65 million in
October 1999, $70 million in November 1999 and $75 million thereafter.
Pursuant to the most recent amendment to the DIP Financing, the aggregate
borrowing limitations under the Tranche A Loan are limited to approximately
$48 million until maturity and are reduced for asset sales made by the
Company. In addition, Tranche B Loan aggregate borrowings are limited to $23
million as a result of the most recent amendment to the DIP Financing.
Borrowings under the Tranche B Loan require the approval of lenders holding at
least 75% of the credit exposure under the DIP Financing. The DIP Financing is
secured by substantially all of the assets of the Company and its
subsidiaries, including certain owned real property. The DIP Financing
contains standard representations and warranties and other affirmative and
restrictive covenants. At December 31, 2000, there were no outstanding
borrowings under the DIP Financing.
Since the consummation of the DIP Financing, the Company and the lenders
under the DIP Financing (the "DIP Lenders") have agreed to several amendments
to the DIP Financing. These amendments approved various changes to the DIP
Financing including (a) extending the period of time for the Company to file
its plan of reorganization, (b) approving certain transactions, (c) revising
the Company's cash plan originally submitted with the DIP Financing and (d)
revising certain financial covenants.
In the most recent amendment to the DIP Financing, the parties agreed, among
other things, to extend the maturity date of the DIP Financing until March 31,
2001 and to revise and update certain financial covenants.
In addition, the most recent amendment extends the period of time for the
Company to file the appropriate pleadings to request confirmation and
consummation of the Amended Plan through March 31, 2001. At December 31, 2000,
the Company was in compliance with the terms of the DIP Financing.
The Company expects to terminate the DIP Financing on or prior to the
effective date of the Amended Plan.
Events Leading to Reorganization
The Company reported a net loss from operations in 1998 aggregating $578
million, resulting in certain financial covenant violations under the
Company's $1.0 billion bank credit facility (the "Credit Agreement"). Prior to
the commencement of the Chapter 11 Cases, the Company received a series of
temporary waivers of these covenant violations. The waivers generally included
certain borrowing limitations under the $300 million revolving credit portion
of the Credit Agreement. The final waiver was scheduled to expire on September
24, 1999.
The Company was informed on April 9, 1999 by HCFA that the Medicare program
had made a demand for repayment of approximately $90 million of reimbursement
overpayments. On April 21, 1999, the Company reached an agreement with HCFA to
extend the repayment of such amounts over 60 monthly installments (the "HCFA
Agreement"). Under the HCFA Agreement, non-interest bearing monthly payments
of approximately $1.5 million commenced in May 1999. Beginning in December
1999, interest began to accrue on the balance of the overpayments at a
statutory rate approximating 13.4%, resulting in a monthly payment of
approximately $2.0 million through March 2004. If the Company is delinquent
with two consecutive payments, the HCFA Agreement will be defaulted and all
subsequent Medicare reimbursement payments to the Company may be withheld.
Amounts due under the HCFA Agreement aggregated $63.4 million at December 31,
2000 and have been classified as liabilities subject to compromise in the
Company's consolidated balance sheet. The Company
7
has received Bankruptcy Court approval to continue to make the monthly payments
under the HCFA Agreement during the pendency of the Chapter 11 Cases.
On May 3, 1999, the Company elected not to make the interest payment of
approximately $14.8 million due on the 1998 Notes. The failure to pay interest
resulted in an event of default under the 1998 Notes.
In accordance with generally accepted accounting principles, outstanding
borrowings under the Credit Agreement ($511 million) and the principal amount
of the 1998 Notes ($300 million) have been presented as liabilities subject to
compromise in the Company's consolidated balance sheet at December 31, 2000. If
the Chapter 11 Cases had not been filed, the Company would have reported a
working capital deficit approximating $942 million at December 31, 2000. The
consolidated financial statements do not include any adjustments that might
result from the resolution of the Chapter 11 Cases or other matters discussed
herein. During the pendency of the Chapter 11 Cases, the Company is continuing
to record the contractual amount of interest expense related to the Credit
Agreement. No interest costs have been recorded related to the 1998 Notes since
the filing of the Chapter 11 Cases. Contractual interest expense for the 1998
Notes not recorded in the consolidated statement of operations aggregated $30
million in 2000 and $9 million in 1999.
As previously reported, the Company was informed by the DOJ that the Company
and Ventas are the subjects of ongoing investigations into various Medicare
reimbursement issues, including hospital cost reporting issues, Vencare billing
practices and various quality of care issues in the hospitals and nursing
centers formerly operated by Ventas and currently operated by the Company. In
connection with the Amended Plan, the claims of the DOJ will be settled through
the Government Settlement. The Government Settlement also provides for the
dismissal of certain pending claims and lawsuits filed against the Company.
See "Legal Proceedings."
Agreements with Ventas
On March 18, 1999, the Company served Ventas with a demand for mediation
pursuant to the Agreement and Plan of Reorganization governing the Spin-off
(the "Spin-off Agreement"). The Company was seeking a reduction in rent and
other concessions under its Master Lease Agreements (as defined) with Ventas.
Shortly thereafter, the Company and Ventas entered into a series of standstill
and tolling agreements which provided that both companies would postpone any
claims either may have against the other and extend any applicable statutes of
limitation.
As a result of the Company's failure to pay rent, Ventas served the Company
with notices of nonpayment under the Master Lease Agreements. Subsequently, the
Company and Ventas entered into further amendments to the second standstill and
the tolling agreements to extend the time during which no remedies may be
pursued by either party and to extend the date by which the Company may cure
its failure to pay rent.
In connection with the Chapter 11 Cases, the Company and Ventas entered into
a stipulation (the "Stipulation") that provides for the payment by the Company
of a reduced aggregate monthly rent of approximately $15.1 million. The
Stipulation has been approved by the Bankruptcy Court. The difference between
the base rent under the Master Lease Agreements and the reduced aggregate
monthly rent is being accrued as an administrative expense subject to
compromise in the Chapter 11 Cases.
The Stipulation also continues to toll any statutes of limitations for claims
that might be asserted by the Company against Ventas and provides that the
Company will continue to fulfill its indemnification obligations arising from
the Spin-off. The Stipulation automatically renews for one-month periods unless
either party provides a 14-day notice of termination. The Stipulation will be
terminated upon the effective date of the Amended Plan. See "Legal
Proceedings."
On May 31, 2000, the Company announced that the Bankruptcy Court had approved
a tax stipulation agreement between the Company and Ventas (the "Tax
Stipulation"). The Tax Stipulation provides that certain
8
refunds of federal, state and local taxes received by either party on or after
September 13, 1999 will be held by the recipient of such refunds in segregated
interest bearing accounts. The Tax Stipulation requires notification before
either party can withdraw funds from the segregated accounts and will terminate
upon the effective date of the Amended Plan.
The Company believes that the Amended Plan, if consummated, will resolve all
material disputes between the Company and Ventas. The Amended Plan also
provides for comprehensive mutual releases between the Company and Ventas,
other than for obligations that the Company is assuming under the Amended Plan.
If the Amended Plan does not become effective and the Company and Ventas are
unable to otherwise resolve their disputes or maintain an interim resolution,
the Company may seek to pursue claims against Ventas arising out of the Spin-
off and seek judicial relief barring Ventas from exercising any remedies based
on the Company's failure to pay some or all of the rent to Ventas. The
Company's failure to pay rent or otherwise comply with the Stipulation, in the
absence of judicial relief, would result in an "Event of Default" under the
Master Lease Agreements. Upon an Event of Default under the Master Lease
Agreements, assuming Ventas were to be granted relief from the automatic stay
by the Bankruptcy Court, the remedies available to Ventas include, without
limitation, terminating the Master Lease Agreements, repossessing and reletting
the leased properties and requiring the Company to (a) remain liable for all
obligations under the Master Lease Agreements, including the difference between
the rent under the Master Lease Agreements and the rent payable as a result of
reletting the leased properties or (b) pay the net present value of the rent
due for the balance of the terms of the Master Lease Agreements. Such remedies,
however, would be subject to the supervision of the Bankruptcy Court.
General
On September 14, 1999, the Company received approval from the Bankruptcy
Court to pay pre-petition and post-petition employee wages, salaries, benefits
and other employee obligations. The Bankruptcy Court also approved orders
granting authority, among other things, to pay pre-petition claims of certain
critical vendors, utilities and patient obligations. All other pre-petition
liabilities are classified in the consolidated balance sheet as liabilities
subject to compromise. The Company currently is paying the post-petition claims
of all vendors and providers in the ordinary course of business.
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
against the Company are subject to an automatic stay and other contractual
obligations against the Company may not be enforced. The automatic stay does
not necessarily apply to certain actions against Ventas for which the Company
has agreed to indemnify Ventas in connection with the Spin-off. In addition,
the Company may assume or reject executory contracts, including lease
obligations, under the Bankruptcy Code. Parties affected by these rejections
may file claims with the Bankruptcy Court in accordance with the reorganization
process.
Liabilities Subject to Compromise
A substantial portion of pre-petition liabilities are subject to settlement
under the Amended Plan. "Liabilities subject to compromise" refers to
liabilities incurred prior to the commencement of the Chapter 11 Cases. These
liabilities, consisting primarily of long-term debt, amounts due to third-party
payors and certain accounts payable and accrued liabilities, represent the
Company's estimate of known or potential claims to be resolved in connection
with the Chapter 11 Cases. Such claims remain subject to future adjustments
based on assertions of additional claims, negotiations, actions of the
Bankruptcy Court, further developments with respect to disputed claims, future
rejection of executory contracts or unexpired leases, determination as to the
value of any collateral securing claims and other events. Proposed payment
terms for these amounts are set forth in the Amended Plan.
All pre-petition liabilities, other than those for which the Company has
received Bankruptcy Court approval to pay, are classified in the consolidated
balance sheet as liabilities subject to compromise. A
9
summary of the principal categories of claims classified as liabilities subject
to compromise under the Chapter 11 Cases follows (in thousands):
December 31, December 31,
2000 1999
------------ ------------
Long-term debt:
Credit Agreement................................. $ 510,908 $ 506,114
1998 Notes....................................... 300,000 300,000
Amounts due under the HCFA Agreement............. 63,405 80,296
8 5/8% Senior Subordinated Notes................. 2,391 2,391
Unamortized deferred financing costs............. (10,306) (12,626)
Other............................................ 2,873 4,592
---------- ----------
869,271 880,767
---------- ----------
Due to third-party payors.......................... 116,062 112,694
Accounts payable................................... 36,053 33,693
Income taxes....................................... 13,478 -
Accrued liabilities:
Interest......................................... 90,655 45,521
Ventas rent...................................... 81,902 33,884
Other............................................ 52,952 52,858
---------- ----------
225,509 132,263
---------- ----------
$1,260,373 $1,159,417
========== ==========
Substantially all of the liabilities subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.
HEALTHCARE OPERATIONS
The Company is organized into two operating divisions: the health services
division, which provides long-term care services by operating nursing centers
and a rehabilitation therapy business and the hospital division, which provides
long-term acute care to medically complex patients by operating hospitals and
an institutional pharmacy business.
The Company believes that the independent focus of each division on the
unique aspects and quality concerns of their respective businesses enhances
their ability to attract patients, improve operations and achieve cost
containment objectives.
The Company believes that the demand for long-term care is increasing.
Improved medical care and advances in medical technology continue to increase
the survival rates for victims of disease and trauma. Many of these patients
never fully recover and require long-term care. The incidence of chronic
medical complications increases with age, particularly in connection with
certain degenerative conditions. As the average age of the United States
population increases, the Company believes that there will be an increase in
the demand for long-term care at all levels of the continuum of care.
At the same time, the long-term care industry is continuing to experience
significant changes. Some of the significant factors affecting the long-term
care industry include the Medicare prospective payment system ("PPS") for
nursing centers and other cost containment measures resulting from the Balanced
Budget Act of 1997 (the "Budget Act"), heightened regulatory scrutiny by
federal and state regulators, the dramatic increase in the costs of defending
and insuring against alleged patient care liability claims, the expansion of
managed care, and an increased public awareness of healthcare spending by
governmental agencies at the federal and state levels.
10
As a result of reimbursement reductions imposed under the Budget Act, most
providers have been required to deliver quality patient care more efficiently.
Medicare revenues recorded under PPS in the Company's health services division
have been substantially less than the cost-based reimbursement it received
before the enactment of the Budget Act. PPS has dramatically affected the
operations of substantially all companies in the long-term care industry. The
Budget Act also reduced payments made to the Company's hospitals by reducing
incentive payments, allowable costs for capital expenditures and bad debts, and
payments for services to patients transferred from a general acute care
hospital. Increased regulatory scrutiny and costs associated with patient care
liability claims, particularly on large for-profit, multi-facility providers,
also have had a significant negative impact on the long-term care industry.
As a result of significant declines in the demand for ancillary services
caused by the Budget Act, the Company completed a realignment of its former
Vencare division in the fourth quarter of 1999. Vencare's physical
rehabilitation, speech and occupational therapies were integrated into the
Company's health services division. Vencare's institutional pharmacy business
was assigned to the hospital division. Vencare's respiratory therapy and other
ancillary businesses were discontinued.
HEALTH SERVICES DIVISION
At December 31, 2000, the health services division provided long-term
healthcare and rehabilitation services in 312 nursing centers containing 40,189
licensed beds located in 31 states. At December 31, 2000, the Company owned six
nursing centers, leased 272 nursing centers from third parties and managed 34
nursing centers.
The Company's nursing centers provide residents with routine long-term care
services, including daily dietary, social and recreational services and a full
range of pharmacy and medical services. The nursing centers also provide
rehabilitation services, including physical, occupational and speech therapies.
In addition, management believes that the Company is a leading provider of care
for patients with Alzheimer's disease. The Company offers specialized programs
at more than 80 nursing centers for patients suffering from Alzheimer's
disease. Most of these patients reside in separate units within the nursing
centers and are cared for by teams of professionals specializing in the unique
problems experienced by Alzheimer's patients.
Since the Vencare realignment in 1999, the health services division has
provided physical, occupational and speech therapies primarily to nursing
center patients. The health services division has 267 contracts to provide
rehabilitation services to patients at facilities not operated by the health
services division.
Health Services Division Strategy
The strategy of the health services division is to improve its patient census
by providing quality, clinical-based services. The health services division is
focused on qualitative and quantitative performance indicators with the goal of
providing quality care under the cost containment objectives imposed by
government and private payors. The health services division is refining its
method of delivering services to create the optimal strategy of providing
quality care, based on clinical outcomes, within the constraints of PPS. The
health services division's ability to control costs, including its labor costs,
will significantly impact its future operating results.
The factors which affect consumers' selection of a nursing center vary by
community and include a nursing center's competitive position and its
relationships with local referral sources. Nursing centers in a given market
are judged by various referral sources, which include physicians, hospital
discharge planners, community organizations and families. Nursing center
marketing efforts are conducted at the local market level by the nursing center
administrators and admissions coordinators. Nursing center personnel are
assisted in carrying out their marketing strategies by regional marketing
staffs. The marketing efforts of the health services division focuses on the
quality of care provided at its facilities with the goal of increasing patient
census levels.
11
In addition, the Company believes there will be an increase in the need for
nursing center services as the average age of the United States population
increases.
The health services division continues to refine the delivery of ancillary
services to external customers to maintain profitability under the cost
constraints of PPS. Since the Vencare realignment, the Company's nursing
centers generally provide ancillary services to patients through the use of
internal staff. The health services division has terminated many unprofitable
external ancillary services contracts in response to the economic conditions
facing the long-term care industry.
Selected Health Services Division Operating Data
The following table sets forth certain operating data for the health services
division after reflecting the realignment of the former Vencare businesses for
all periods presented (dollars in thousands, except statistics):
Year Ended December 31,
-----------------------------------
2000 1999 1998
----------- ----------- -----------
Nursing centers:
Revenues............................. $ 1,675,627 $ 1,594,244 $ 1,667,343
Operating income (restated).......... $ 278,738 $ 169,128 $ 213,036
Facilities in operation at end of
period:
Owned or leased.................... 278 282 278
Managed............................ 34 13 13
Licensed beds at end of period:
Owned or leased.................... 36,466 36,912 36,701
Managed............................ 3,723 1,661 1,661
Patient days (a)..................... 11,580,295 11,656,439 11,939,266
Revenues per patient day (a)......... $ 145 $ 137 $ 140
Average daily census (a)............. 31,640 31,935 32,710
Occupancy % (a)...................... 86.1 86.8 87.3
Rehabilitation services:
Revenues............................. $ 135,036 $ 195,731 $ 264,574
Operating income (restated).......... $ 8,047 $ 2,891 $ 18,398
Other ancillary services:
Revenues............................. $ - $ 43,527 $ 168,165
Operating income..................... $ 4,737 $ 4,166 $ 30,183
--------
(a)Excludes managed facilities.
As used in the above table, the term "operating income" is defined as
earnings before interest, income taxes, depreciation, amortization, rent,
corporate overhead and unusual transactions. The term "licensed beds" refers to
the maximum number of beds permitted in the facility under its license
regardless of whether the beds are actually available for patient care.
"Patient days" refers to the total number of days of patient care provided for
the periods indicated. "Average daily census" is computed by dividing each
facility's patient days by the number of calendar days the respective facility
is in operation. "Occupancy %" is computed by dividing average daily census by
the number of licensed beds, adjusted for the length of time each facility was
in operation during each respective period.
Total assets of the health services division were $495 million and $489
million at the end of 2000 and 1999, respectively.
12
Sources of Nursing Center Revenues
Nursing center revenues are derived principally from Medicare and Medicaid
programs and from private payment patients. Consistent with the nursing center
industry, changes in the mix of the health services division's patient
population among these three categories significantly affect the profitability
of its operations. Although Medicare and higher acuity patients generally
produce the most revenue per patient day, profitability with respect to higher
acuity patients is reduced by the costs associated with the higher level of
nursing care and other services generally required by such patients. The
Company believes that private payment patients generally constitute the most
profitable category and Medicaid patients generally constitute the least
profitable category.
The following table sets forth the approximate percentages of nursing center
patient days and revenues derived from the payor sources indicated:
Private and
Medicare Medicaid Other
---------------- ---------------- ----------------
Patient Patient Patient
Year Days Revenues Days Revenues Days Revenues
---- ------- -------- ------- -------- ------- --------
2000...................... 13% 28% 67% 49% 20% 23%
1999...................... 12 26 66 49 22 25
1998...................... 13 29 65 45 22 26
For the year ended December 31, 2000, revenues of the health services
division totaled approximately $1.7 billion or 59% of the Company's total
revenues (before eliminations).
Both governmental and private third-party payors employ cost containment
measures designed to limit payments made to healthcare providers. Those
measures include the adoption of initial and continuing recipient eligibility
criteria which may limit payment for services, the adoption of coverage
criteria which limit the services that will be reimbursed and the establishment
of payment ceilings which set the maximum reimbursement that a provider may
receive for services. Furthermore, government reimbursement programs are
subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and government funding restrictions, all of which may
materially increase or decrease the rate of program payments to the health
services division for its services.
Medicare. The Medicare Part A program provides reimbursement for extended
care services furnished to Medicare beneficiaries who are admitted to nursing
centers after at least a three-day stay in an acute care hospital. Covered
services include supervised nursing care, room and board, social services,
physical and occupational therapies, pharmaceuticals, supplies and other
necessary services provided by nursing centers.
Prior to the implementation of PPS, Medicare nursing center reimbursement was
based upon reasonable direct and indirect costs of services provided to
patients. The Budget Act established PPS for nursing centers for cost reporting
periods beginning on or after July 1, 1998. All of the Company's nursing
centers adopted PPS on July 1, 1998. During the first three years, the per diem
rates for nursing centers are based on a blend of facility-specific costs and
federal costs. Thereafter, the per diem rates will be based solely on federal
costs. The payments received under PPS cover all services for Medicare patients
including all ancillary services, such as respiratory therapy, physical
therapy, occupational therapy, speech therapy and certain covered
pharmaceuticals. Since November 1999, various legislative and regulatory
actions have provided a measure of relief from some of the impact of the Budget
Act. Despite the effects of these recent actions, the Medicare revenues
recorded under PPS in the Company's nursing centers have been substantially
less than the cost-based reimbursement received before the enactment of the
Budget Act. See "--Governmental Regulation--Regulatory Changes" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Medicaid. Medicaid is a state-administered program financed by state funds
and matching federal funds. The program provides for medical assistance to the
indigent and certain other eligible persons. Although administered under broad
federal regulations, states are given flexibility to construct programs and
payment
13
methods consistent with their individual goals. Accordingly, these programs
differ from state to state in many respects.
Prior to the Budget Act, federal law, generally referred to as the "Boren
Amendment," required Medicaid programs to pay rates that were reasonable and
adequate to meet the costs incurred by an efficiently and economically operated
nursing center providing quality care and services in conformity with all
applicable laws and regulations. Despite the federal requirements,
disagreements frequently arose between nursing centers and states regarding the
adequacy of Medicaid payments. By repealing the Boren Amendment, the Budget Act
eases the restrictions on the states' ability to reduce their Medicaid
reimbursement levels for such services. In addition, Medicaid programs are
subject to statutory and regulatory changes, administrative rulings,
interpretations of policy by the state agencies and certain government funding
limitations, all of which may materially increase or decrease the level of
program payments to nursing centers operated by the health services division.
Management believes that the payments under many of these programs may not be
sufficient on an overall basis to cover the costs of serving certain patients
participating in these programs. Furthermore, the Omnibus Budget Reconciliation
Act of 1987, as amended, mandates an increased emphasis on ensuring quality
patient care, which has resulted in additional expenditures by nursing centers.
The health services division provides to eligible individuals Medicaid-covered
services consisting of nursing care, room and board and social services. In
addition, states may at their option cover other services such as physical,
occupational and speech therapies and pharmaceuticals.
Private Payment. The health services division seeks to maximize the number of
private payment patients admitted to its nursing centers, including those
covered under private insurance and managed care health plans. Private payment
patients typically have financial resources (including insurance coverage) to
pay for their monthly services and do not rely on government programs for
support.
There can be no assurance that payments under governmental and private third-
party payor programs will remain at levels comparable to present levels or will
be sufficient to cover the costs allocable to patients eligible for
reimbursement pursuant to such programs. In addition, there can be no assurance
that facilities operated by the health services division, or the provision of
services and supplies by the health services division, will meet the
requirements for participation in such programs. The Company could be affected
adversely by the continuing efforts of governmental and private third-party
payors to contain the amount of reimbursement for healthcare services.
14
Nursing Center Facilities
The following table lists by state the number of nursing centers and related
licensed beds owned by the Company or leased from Ventas and other third
parties as of December 31, 2000:
Number of Facilities
---------------------------------------------------
Licensed Owned by Leased from Leased from
State Beds the Company Ventas(2) Other Parties Managed Total
----- -------- ----------- ----------- ------------- ------- -----
Alabama(1).............. 781 - 3 1 2 6
Arizona................. 1,393 - 6 - 6 12
California.............. 2,205 1 11 4 2 18
Colorado................ 695 - 4 1 - 5
Connecticut(1).......... 983 - 8 - - 8
Florida(1).............. 2,713 2 15 1 2 20
Georgia(1).............. 1,211 - 5 4 - 9
Idaho................... 867 1 8 - - 9
Indiana................. 5,075 - 14 15 6 35
Kentucky(1)............. 2,080 1 12 4 - 17
Louisiana(1)............ 485 - - 1 2 3
Maine(1)................ 775 - 10 - - 10
Massachusetts(1)........ 4,039 - 31 3 2 36
Mississippi(1).......... 125 - - 1 - 1
Montana(1).............. 446 - 2 1 - 3
Nebraska(1)............. 163 - 1 - - 1
Nevada(1)............... 180 - 2 - - 2
New Hampshire(1)........ 622 - 3 - 1 4
North Carolina(1)....... 2,764 - 19 4 - 23
Ohio(1)................. 2,155 - 11 4 1 16
Oregon(1)............... 254 - 2 - - 2
Pennsylvania............ 200 - 1 1 - 2
Rhode Island(1)......... 201 - 2 - - 2
Tennessee(1)............ 2,541 - 4 11 - 15
Texas................... 1,521 - 1 2 8 11
Utah.................... 848 - 5 1 1 7
Vermont(1).............. 310 - 1 - 1 2
Virginia(1)............. 749 - 4 1 - 5
Washington(1)........... 1,012 1 9 - - 10
Wisconsin(1)............ 2,345 - 12 2 - 14
Wyoming................. 451 - 4 - - 4
------ --- --- --- --- ---
Totals................ 40,189 6 210 62 34 312
====== === === === === ===
--------
(1) These states have Certificate of Need ("CON") regulations. See "--
Governmental Regulation--Health Services Division."
(2)See "--Master Lease Agreements."
Health Services Division Management and Operations
A divisional president and a chief financial officer manage the health
services division. The nursing center operations of the division are divided
into four geographic regions with each region headed by an operational vice
president, each of whom reports to the divisional president. Ancillary services
operations also are managed by a vice president who reports to the divisional
president. The health services division is supported by district and/or
regional staff in the areas of nursing, dietary and rehabilitation services,
state and federal reimbursement, human resources management, maintenance, sales
and financial services. In addition, the Company's corporate headquarters
provides other services in the areas of information systems, human resources
management, state
15
and federal reimbursement, state licensing and certification, legal, finance
and accounting support, purchasing and facilities management. Financial control
is maintained principally through fiscal and accounting policies.
Each nursing center is managed by a state-licensed administrator who is
supported by other professional personnel, including a director of nursing,
staff development professional (responsible for employee training), activities
director, social services director, licensed dietitian, business office manager
and, in general, physical, occupational and speech therapists. The directors of
nursing are state-licensed nurses who supervise nursing staff which include
registered nurses, licensed practical nurses and nursing assistants. Staff size
and composition vary depending on the size and occupancy of each nursing center
and on the level of care provided by the nursing center. The nursing centers
contract with physicians who serve as medical directors and serve on quality
assurance committees.
Quality Assessment and Improvement
Quality of care is monitored and enhanced by quality assurance or performance
improvement committees and family satisfaction surveys. These committees
oversee patient healthcare needs and patient and staff safety. Additionally,
physicians serve on these committees as medical directors and advise on
healthcare policies and practices. Regional and district nursing professionals
visit each nursing center periodically to review practices and recommend
improvements where necessary in the level of care provided and to assure
compliance with requirements under applicable Medicare and Medicaid
regulations. Surveys of patients' families are conducted from time to time in
which the families are asked to rate various aspects of service and the
physical condition of the nursing centers. These surveys are reviewed by
performance improvement committees at each facility to promote quality patient
care.
The health services division provides training programs for nursing center
administrators, managers, nurses and nursing assistants. These programs are
designed to maintain high levels of quality patient care.
Substantially all of the nursing centers currently are certified to provide
services under Medicare and Medicaid programs. A nursing center's qualification
to participate in such programs depends upon many factors, such as
accommodations, equipment, services, safety, personnel, physical environment
and adequate policies and procedures.
Health Services Division Competition
The nursing centers operated by the health services division compete on a
local and regional basis with other nursing centers and other long-term
healthcare providers. The competitive position varies within each community
served. The Company believes that the quality of care, reputation, location and
physical appearance of its nursing centers and, in the case of private
patients, the charges for services, are significant competitive factors. Some
competitors are located in buildings that are newer than those operated by the
health services division and may provide services not offered by the health
services division. Although there is limited, if any, price competition with
respect to Medicare and Medicaid patients (since revenues received for services
provided to such patients are based generally on fixed rates), there is
significant competition for private payment patients.
Although the ancillary services markets are fragmented, significant
competition exists for these services. The primary competitive factors for the
ancillary services markets are quality of services, charges for services and
responsiveness to the needs of patients, families and the facilities in which
the services are provided. In addition, many nursing centers are developing
internal staff to provide these services, particularly in response to the
implementation of PPS.
The long-term care industry is divided into a variety of competitive areas
which market similar services. These competitors include nursing centers,
hospitals, extended care centers, assisted living facilities, home health
agencies and similar institutions. The industry includes government-owned,
church-owned, secular not-for-profit and for-profit institutions. Many of these
competitors have greater financial and other resources than the Company.
16
HOSPITAL DIVISION
The Company's hospitals primarily provide long-term acute care to medically
complex patients. These hospitals treat patients who suffer from multiple
systemic failures or conditions such as neurological disorders, head injuries,
brain stem and spinal cord trauma, cerebral vascular accidents, chemical brain
injuries, central nervous system disorders, developmental anomalies and
cardiopulmonary disorders. Medically complex patients often are dependent on
technology for continued life support, such as mechanical ventilators, total
parental nutrition, respiration or cardiac monitors and dialysis machines.
Approximately 50% of the hospital division's medically complex patients are
ventilator-dependent for some period of time during their hospitalization.
The hospital division's patients suffer from conditions which require a high
level of monitoring and specialized care, yet may not need the services of an
intensive care unit. Due to their severe medical conditions, the hospital
division's patients generally are not clinically appropriate for admission to a
nursing center. Their medical condition is periodically or chronically
unstable. By combining general acute care services with the ability to care for
medically complex patients, the Company believes that its long-term care
hospitals provide their patients with high quality, cost-effective care.
During 2000, the average length of stay for patients in its long-term care
hospitals was approximately 36 days. Although the hospital division's patients
range in age from pediatric to geriatric, approximately 70% of the hospital
division's patients are over 65 years of age. Hospital operations are regulated
by a number of government and private agencies. See "--Governmental
Regulation--Hospital Division."
Services Provided by the Hospital Division
Medically Complex. The Company's long-term acute care hospitals use a
comprehensive program of care for its medically complex patients that draws
upon the talents of interdisciplinary teams, including licensed pulmonary
specialists. The teams evaluate medically complex patients upon admission to
determine treatment programs. The hospital division has developed specialized
treatment programs focused on the needs of medically complex patients. Where
appropriate, the treatment programs may involve the services of several
disciplines, such as pulmonary and physical therapy. Individual attention to
patients who have the cognitive and physical abilities to respond to therapy is
emphasized.
General Acute Care. The hospital division operates two general acute care
hospitals and one surgical hospital. Certain of the hospital division's long-
term care hospitals also provide outpatient services in support of their long-
term care services. General acute care and outpatient services may include
inpatient services, diagnostic services, CT scanning, one-day surgery,
laboratory, X-ray, respiratory therapy, cardiology and physical therapy.
Pharmacies. Since the Vencare realignment in 1999, the hospital division has
provided institutional pharmacy services. The institutional pharmacy business
focuses on providing a full array of institutional pharmacy services to nursing
centers and specialized care centers, including nursing centers operated by the
Company. Institutional pharmacy sales encompass a wide variety of products
including prescription medication, prosthetics and respiratory services.
Hospital Division Strategy
The hospital division differentiates its hospitals as a result of its ability
to care for medically complex patients in a high quality, cost-effective
setting. The hospital division is committed to maintaining its quality of care
by dedicating appropriate resources to each of its hospitals. In addition, the
hospital division is focusing its efforts on containing and reducing costs to
operate competitively under the reduced Medicare reimbursement established by
the Budget Act while maintaining quality care. The hospital division seeks to
improve operating efficiencies and reduce costs by standardizing operations and
optimizing staffing based on the hospital's occupancy and the clinical needs of
its patients. The hospital division has developed a patient classification
17
system called Customcare(TM) that is designed to ensure that patients receive
the necessary level of care. This model allows the hospital division to
monitor employee skill mix and manage labor costs. The hospital division's
ability to control costs, including its labor costs, will significantly impact
its future operating results.
The hospital division intends to market aggressively its quality of care
standards and broaden its expertise beyond pulmonary services in specific
markets.
The Company believes that the demand for long-term care is increasing as the
average age of the United States population increases. The incidence of
respiratory problems increases with age, particularly in connection with
certain degenerative conditions.
In addition, medically displaced patients that require a high level of
monitoring and specialized care, yet may not require the continued services of
an intensive care unit, provide a patient base for the Company's hospitals.
Due to their extended recovery period, these patients generally would not
receive specialized multi-disciplinary treatment focused on the unique aspects
of a long-term recovery program in a general acute care hospital, and yet are
not appropriate for admission to a nursing center or rehabilitation hospital.
The hospital division also benefits from historical reimbursement policies
and practices that make it difficult to place medically complex patients in an
appropriate healthcare setting. Under the Medicare program, general acute care
hospitals are reimbursed under a prospective payment system or a fixed payment
system which provides an economic incentive to general acute care hospitals to
minimize the length of a patient's stay. As a result, these hospitals
generally receive less than full cost for providing care to patients with
extended lengths of stay. Furthermore, the prospective payment system does not
provide for reimbursement more frequently than once every 60 days, placing an
additional economic burden on a general acute care hospital providing long-
term care. The long-term acute care hospitals operated by the hospital
division, however, are excluded from the prospective payment system and
generally receive reimbursement on a more favorable basis for providing long-
term hospital care to Medicare patients. Commercial reimbursement sources,
such as insurance companies, managed care companies and health maintenance
organizations ("HMOs"), some of which pay based on established hospital
charges, typically seek the most economical source of care available.
The hospital division seeks to increase its admissions by expanding and
improving its relationship with physicians, general acute care hospitals and
other discharge planners by emphasizing its quality of care and its cost-
effective setting.
Selected Hospital Division Operating Data
The following table sets forth certain operating data for the hospital
division after reflecting the realignment of the former Vencare businesses for
all periods presented (dollars in thousands, except statistics):
Year Ended December 31,
----------------------------
2000 1999 1998
---------- -------- --------
Hospitals:
Revenues..................................... $1,007,947 $850,548 $919,847
Operating income (restated).................. $ 205,858 $132,050 $247,272
Facilities in operation at end of period..... 56 56 57
Licensed beds at end of period............... 4,886 4,931 4,979
Patient days................................. 1,044,663 982,301 947,488
Revenues per patient day..................... $ 965 $ 866 $ 971
Average daily census......................... 2,854 2,691 2,596
Occupancy %.................................. 60.8 56.9 54.0
Pharmacy:
Revenues..................................... $ 204,252 $171,493 $149,991
Operating income (restated).................. $ 7,421 $ 342 $ 15,301
18
Total assets of the hospital division were $354 million and $337 million at
the end of 2000 and 1999, respectively.
Sources of Hospital Revenues
The hospital division receives payment for hospital services from third-party
payors, including government reimbursement programs such as Medicare and
Medicaid and non-government sources such as commercial insurance companies,
HMOs, preferred provider organizations ("PPOs") and contracted providers.
Patients covered by non-government payors generally will be more profitable to
the hospital division than those covered by Medicare and Medicaid programs. The
following table sets forth the approximate percentages of the hospital patient
days and revenues derived from the payor sources indicated:
Private and
Medicare Medicaid Other
---------------- ---------------- ----------------
Patient Patient Patient
Year Days Revenues Days Revenues Days Revenues
---- ------- -------- ------- -------- ------- --------
2000...................... 67% 55% 13% 10% 20% 35%
1999...................... 68 58 12 11 20 31
1998...................... 68 59 13 10 19 31
For the year ended December 31, 2000, revenues of the hospital division
totaled approximately $1.2 billion or 41% of the Company's total revenues
(before eliminations). Changes caused by the Budget Act have reduced Medicare
payments made to the hospital division related to incentive payments under the
Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), allowable costs for
capital expenditures and bad debts, and payments for services to patients
transferred from a general acute care hospital. See "--Governmental
Regulation--Regulatory Changes" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
19
Hospital Facilities
The following table lists by state the number of hospitals and related
licensed beds owned by the Company or leased from Ventas and other third
parties as of December 31, 2000:
Number of Facilities
-------------------------------------------
Licensed Owned by Leased from Leased from
State Beds the Company Ventas(2) Other Parties Total
----- -------- ----------- ----------- ------------- -----
Arizona.................... 109 - 2 - 2
California................. 543 2 6 - 8
Colorado................... 68 - 1 - 1
Florida(1)................. 536 - 6 1 7
Georgia(1)................. 72 - - 1 1
Illinois(1)................ 564 - 4 1 5
Indiana.................... 167 - 2 1 3
Kentucky(1)................ 374 - 1 - 1
Louisiana.................. 168 - 1 - 1
Massachusetts(1)........... 86 - 2 - 2
Michigan(1)................ 400 - 2 - 2
Minnesota.................. 92 - 1 - 1
Missouri(1)................ 227 - 2 - 2
Nevada(1).................. 52 - 1 - 1
New Mexico................. 61 - 1 - 1
North Carolina(1).......... 124 - 1 - 1
Oklahoma................... 59 - 1 - 1
Pennsylvania............... 115 - 2 - 2
Tennessee(1)............... 49 - 1 - 1
Texas...................... 714 2 6 2 10
Virginia(1)................ 164 - 1 - 1
Washington(1).............. 80 1 - - 1
Wisconsin.................. 62 1 - - 1
----- --- --- --- ---
Totals................... 4,886 6 44 6 56
===== === === === ===
--------
(1) These states have CON regulations. See "--Governmental Regulation--Hospital
Division."
(2) See "--Master Lease Agreements."
Hospital Patient Admissions
Substantially all of the acute and medically complex patients admitted to the
hospitals are transferred from other healthcare providers. Patients are
referred from general acute care hospitals, rehabilitation hospitals, nursing
centers and home care settings. Referral sources include physicians, discharge
planners, case managers of managed care plans, social workers, third-party
administrators, HMOs and insurance companies.
The hospital division employs case managers who are responsible for, among
other things, educating healthcare professionals from other referral sources as
to the unique nature of the services provided by its long-term care hospitals.
Specifically, case managers train the staffs of discharging institutions about
long-term care hospital services and the types of patients who could benefit
from such services. The case managers are responsible for assisting discharging
institutions in establishing long-term care hospital policies and practices.
These professionals also review referrals and coordinate admissions subsequent
to the referring provider determining that the patient is appropriate for a
long-term care hospital and that the Company's hospital is the appropriate
long-term care hospital. Each hospital maintains a pre-admission assessment
system to evaluate clinical needs and other information in determining the
appropriateness of each patient referral.
20
Professional Staff
Each hospital is staffed with a multi-disciplinary team of healthcare
professionals. A professional nursing staff trained to care for long-term acute
patients is on duty 24 hours each day in the hospitals. Other professional
staff includes respiratory therapists, physical therapists, occupational
therapists, speech therapists, pharmacists, registered dietitians and social
workers.
The physicians at the hospitals are not employees of the Company and may be
members of the medical staff of other hospitals. Each of the hospitals has a
fully credentialed, multi-specialty medical staff to meet the needs of the
medically complex, long-term acute patient. Typically, each patient is visited
at least once a day by a physician. A broad range of physician services is
available including, but not limited to, pulmonology, internal medicine,
infectious diseases, neurology, nephrology, cardiology, radiology and
pathology. Generally, the hospital division does not enter into exclusive
contracts with physicians to provide services to its patients.
The hospital division believes that its future success will depend in part
upon its continued ability to hire and retain qualified healthcare personnel.
Accordingly, the hospital division seeks the highest quality of professional
staff within each market.
Hospital Division Management and Operations
A divisional president and a chief financial officer manage the hospital
division. The operations of the hospitals are divided into three geographic
regions with each region headed by an operational vice president, each of whom
reports to the divisional president. The clinical issues and quality concerns
of the hospital division are managed by the division's chief medical officer
and vice president of clinical operations. Institutional pharmacy operations
also are managed by a vice president who reports to the divisional president.
The Company's corporate headquarters also provides services in the areas of
information systems design and development, training, human resources
management, reimbursement expertise, legal advice, technical accounting
support, purchasing and facilities management. Financial control is maintained
principally through fiscal and accounting policies.
A hospital administrator supervises and is responsible for the day-to-day
operations at each hospital. Each hospital also employs a controller who
monitors the financial matters of each hospital, including the measurement of
actual operating results compared to budgets. In addition, each hospital
employs an assistant administrator to oversee the clinical operations of the
hospital and a quality assurance manager to direct an integrated quality
assurance program.
Quality Assessment and Improvement
The hospital division maintains a strategic outcome program which includes a
centralized pre-admission evaluation program and concurrent review of all of
its patient population against utilization and quality screenings, as well as
quality of life outcomes data collection and patient and family satisfaction
surveys. In addition, each hospital has an integrated quality assessment and
improvement program administered by a quality review manager which encompasses
utilization review, quality improvement, infection control and risk management.
The objective of these programs is to ensure that patients are admitted
appropriately to its hospitals and that quality healthcare is provided in a
cost-effective manner.
The hospital division has implemented a program whereby its hospitals are
reviewed by internal quality auditors for compliance with standards of the
Joint Commission on Accreditation of Health Care Organizations ("JCAHO"). The
purposes of this internal review process are to (a) ensure ongoing compliance
with industry recognized standards for hospitals, (b) assist management in
analyzing each hospital's operations and (c) provide consulting and educational
programs for each hospital to identify opportunities to improve patient care.
21
Hospital Division Competition
As of December 31, 2000, the hospitals operated by the hospital division were
located in 42 geographic markets in 23 states. In each geographic market, there
are general acute care hospitals which provide services comparable to those
offered by the Company's hospitals. In addition, the hospital division believes
that as of December 31, 2000 there were approximately 300 hospitals in the
United States certified by Medicare as general long-term hospitals, some of
which provide similar services to those provided by the hospital division. Many
of these general acute care hospitals and long-term hospitals are larger and
more established than the hospitals operated by the hospital division. Certain
competing hospitals are operated by not-for-profit, nontaxpaying or
governmental agencies, which can finance capital expenditures on a tax-exempt
basis, and which receive funds and charitable contributions unavailable to the
hospital division.
Cost containment efforts by federal and state governments and other third-
party payors designed to encourage more efficient utilization of hospital
services generally have resulted in lower hospital industry occupancy rates in
recent years. As a result of these efforts, a number of acute care hospitals
have converted to specialized care facilities. Some hospitals have developed
step-down units which attempt to serve the needs of patients who require care
at a level between that provided by an intensive care unit and a general
medical/surgical floor. This trend may continue due to the current oversupply
of acute care hospital beds and the increasing consolidation and affiliation of
free-standing hospitals into larger systems. As a result, the hospital division
may experience increased competition from existing hospitals and converted
facilities.
Competition for patients covered by non-government reimbursement sources is
intense. The primary competitive factors in the long-term acute care business
include quality of services, charges for services and responsiveness to the
needs of patients, families, payors and physicians. Other companies have
entered the long-term acute care market with licensed hospitals that compete
with the Company's hospitals.
Some nursing centers, while not licensed as hospitals, have developed units
which provide a greater intensity of care than typically provided by a nursing
center. The condition of patients in these nursing centers is less acute than
the condition of patients in the hospitals operated by the hospital division.
The competitive position of any hospital also is affected by the ability of
its management to negotiate contracts with purchasers of group healthcare
services, including private employers, managed care companies, PPOs and HMOs.
Such organizations attempt to obtain discounts from established hospital
charges. The importance of obtaining contracts with PPOs, HMOs and other
organizations which finance healthcare, and its effect on a hospital's
competitive position, vary from market to market, depending on the number and
market strength of such organizations.
The hospital division also competes with other companies in providing
institutional pharmacy services. Many of these companies have greater financial
and other resources than the Company.
MASTER LEASE AGREEMENTS
As part of the Spin-off, the Company and Ventas entered into four master
lease agreements that set forth the material terms governing the lease of over
250 parcels of real property, buildings and other improvements (primarily
nursing centers and long-term acute care hospitals) operated by the Company.
The leased properties are divided into groups of properties and a master lease
agreement was entered into with respect to each such group of properties. In
August 1998, the Company and Ventas entered into a fifth lease agreement with
respect to a nursing center in Corydon, Indiana (the "Corydon Lease"). The
provisions of the Corydon Lease, except for the provisions relating to rental
amounts and the termination date, are substantially similar to the terms of the
other master lease agreements with Ventas. The four master lease agreements, as
amended, and the Corydon Lease shall be referred to herein collectively as the
"Master Lease Agreements" and each, a "Master Lease Agreement."
22
The following description of the Master Lease Agreements does not purport to
be complete but contains a summary of the material provisions of the Master
Lease Agreements. As part of the Amended Plan, the Company and Ventas will
enter into the Amended Leases which have substantially different terms than
the current Master Lease Agreements. See "--Proceedings under Chapter 11 of
the Bankruptcy Code--Amended Plan of Reorganization."
Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, permanently affixed equipment, and machinery and other fixtures
relating to the operation of the leased properties. There are multiple bundles
of leased properties under each Master Lease Agreement (other than the Corydon
Lease) with each bundle containing approximately seven to twelve leased
properties. All leased properties within a bundle have the same primary terms
ranging from 10 to 15 years (the "Base Term"). At the option of the Company,
all, but not less than all, of the leased properties in a bundle may be
extended for one five-year renewal term beyond the Base Term (the "First
Renewal Term") at the then existing rental rate plus 2% per annum. At the
option of the Company, all, but not less than all, of the leased properties in
a bundle may be extended for two additional five-year renewal terms beyond the
First Renewal Term (together with the First Renewal Term, the "Renewal Term")
at the then fair market value rental rate. The Base Term and Renewal Term of
each leased property are subject to termination upon default by either party
and certain other conditions described in the Master Lease Agreements.
Rental Amounts
Each Master Lease Agreement is commonly known as a triple-net lease or an
absolute-net lease. The aggregate annual rent for the twelve-month period
commencing immediately following the Spin-off for the leased properties was
approximately $222 million, with a 2% per annum escalator over the previous
twelve-month period if certain lessee revenue parameters were obtained. During
2000, the aggregate annual rent was approximately $230 million. In connection
with the Chapter 11 Cases, the Company and Ventas entered into the Stipulation
which provides for the payment by the Company of a reduced aggregate monthly
rent of approximately $15.1 million beginning in September 1999. The
difference between the $19.3 million aggregate monthly rent under the Master
Lease Agreements and the reduced monthly rent under the Stipulation is being
accrued as an administrative expense subject to compromise in the Chapter 11
Cases. During the pendency of the Chapter 11 Cases, the Company is recording
the entire contractual amount of the aggregate monthly rent.
In addition, the Company is required to pay:
. all insurance required in connection with the leased properties and the
business conducted on the leased properties;
. all taxes levied on or with respect to the leased properties (other than
taxes on the net income of Ventas); and
. all utilities and other services necessary or appropriate for the leased
properties and the business conducted on the leased properties.
Use of the Leased Property
The Master Lease Agreements require that the Company utilize each leased
property solely as a hospital or a nursing center and related uses, or as
Ventas may otherwise consent (which consent may not be unreasonably withheld).
The Company is responsible for maintaining or causing to be maintained all
licenses, certificates and permits necessary for it to comply with various
healthcare regulations. The Company is obligated to operate continuously each
leased property as a provider of healthcare services.
23
Events of Default
An "Event of Default" will be deemed to have occurred under any Master Lease
Agreement if, among other things:
. the Company fails to pay rent or other amounts within five days after
notice;
. the Company fails to comply with covenants continuing for 30 days or, so
long as diligent efforts to cure such failure are being made, such longer
period (not to exceed 180 days) as is necessary to cure such failure;
. certain bankruptcy or insolvency events occur, including filing a
petition of bankruptcy or a petition for reorganization under the
Bankruptcy Code;
. the Company ceases to operate any leased property as a provider of
healthcare services for a period of 30 days;
. the Company loses any required healthcare license, permit or approval;
. the Company fails to maintain insurance;
. the Company creates or allows to remain certain liens;
. a reduction occurs in the number of licensed beds in excess of 10% of the
number of licensed beds in the applicable facility on the date the
applicable facility was leased;
. certification for reimbursement under Medicare with respect to a
participating facility is revoked;
. there is any breach of any material representation or warranty of the
Company;
. the Company becomes subject to regulatory sanctions and has failed to
cure or satisfy such regulatory sanctions within its specified cure
period in any material respect with respect to any facility; or
. there is any default under any guaranty of the lease or under certain
indemnity agreements between the Company and Ventas.
Except as noted below, upon an Event of Default under a particular Master
Lease Agreement, Ventas may, at its option, exercise the following remedies:
. after not less than ten days' notice to the Company, terminate the Master
Lease Agreement, repossess the leased property and relet the leased
property to a third party and require the Company pay to Ventas, as
liquidated damages, the net present value of the rent for the balance of
the term, discounted at prime rate;
. without terminating the Master Lease Agreement, repossess the leased
property and relet the leased property with the Company remaining liable
under the Master Lease Agreement for all obligations to be performed by
the Company thereunder, including the difference, if any, between the
rent under the Master Lease Agreement and the rent payable as a result of
the reletting of the leased property; and
. seek any and all other rights and remedies available under law or in
equity.
Certain Events of Default are considered facility-specific events of default.
A facility-specific event of default is caused by:
. the loss of any required healthcare license, permit or approval;
. a reduction in the number of licensed beds in excess of 10% of the number
of licensed beds in the applicable facility or a revocation of
certification for reimbursement under Medicare with respect to any
facility that participates in such programs; or
. the Company becoming subject to regulatory sanctions and failing to cure
or satisfy such regulatory sanctions within its specified cure period.
Upon the occurrence of a facility-specific event of default, Ventas may, if
it so desires, terminate the related Master Lease Agreement with respect to
only the applicable facility that is the subject of the facility-specific event
of default and collect liquidated damages attributable to such facility
multiplied by the number of
24
years remaining on the applicable lease; provided, however, that upon the
occurrence of the fifth facility-specific event of default, determined on a
cumulative basis, Ventas would be permitted to exercise all of the rights and
remedies set forth in the Master Lease Agreement with respect to all facilities
covered under the Master Lease Agreement, without regard to the facility from
which such fifth facility-specific event of default emanated.
Any remedies provided under the Master Lease Agreements currently are subject
to the supervision of the Bankruptcy Court. See "--Proceedings under Chapter 11
of the Bankruptcy Code--Agreements with Ventas."
Maintenance, Modification and Capital Additions
The Company is required to maintain the leased properties in good repair and
condition, making all repairs, modifications and additions required by law,
including any capital addition. The Company is required to pay for all capital
expenditures and other expenses for the maintenance, repair, restoration or
refurbishment of a leased property. The Company also is required to maintain
all personal property at each of the leased properties in good order, condition
and repair, as is necessary to operate the leased property in compliance with
all applicable licensure, certification, legal and insurance requirements and
otherwise in accordance with customary practice in the industry. The Company
may undertake any capital addition that materially adds to or improves a leased
property without the consent of Ventas, subject to the Company delivering to
Ventas the plans and specifications and the Company's compliance with customary
construction requirements.
Insurance
The Company is required to maintain liability, all risk property and workers'
compensation insurance for the leased properties at a level at least comparable
to those in place with respect to the leased properties prior to the Spin-off.
Environmental Matters
The Master Lease Agreements provide that the Company will indemnify Ventas
(and its officers, directors and stockholders) against any environmental claims
(including penalties and clean-up costs) resulting from any condition arising
on or under, or relating to, the leased properties at any time on or after the
commencement date of the Master Lease Agreements. The Company also will
indemnify Ventas (and its officers, directors and stockholders) against any
environmental claim (including penalties and clean-up costs) resulting from any
condition permitted to deteriorate on or after the commencement date of the
Master Lease Agreements. Ventas has agreed to indemnify the Company (and its
officers, directors and stockholders) against any environmental claims
(including penalties and clean-up costs) resulting from any condition arising
on or under, or relating to, the leased properties at any time before the
commencement date of the Master Lease Agreements.
Assignment and Subletting
The Master Lease Agreements provide that the Company may not assign, sublease
or otherwise transfer any leased property or any portion of a leased property
as a whole (or in substantial part), including upon a change of control (as
defined in the Master Lease Agreements), without the consent of Ventas, which
may not be unreasonably withheld if the proposed assignee is a creditworthy
entity with sufficient financial stability to satisfy its obligations under the
related Master Lease Agreement, has not less than four years experience in
operating healthcare facilities, has a favorable business and operational
reputation and character and agrees to comply with the use restrictions in the
related Master Lease Agreement. The obligation of Ventas to consent to a
subletting or assignment is subject to the reasonable approval rights of any
mortgagee and/or the lenders under its credit agreement. The Company may
sublease up to 20% of each leased property for restaurants, gift shops and
other stores or services customarily found in hospitals or nursing centers
without the consent of Ventas, subject, however, to there being no material
alteration in the character of the leased property or in the nature of the
business conducted on such leased property.
25
Right of First Refusal to Purchase
The Master Lease Agreement provides that if Ventas receives a bona fide offer
from a third party to purchase any leased property during the first three years
of the term and Ventas wishes to accept the offer, prior to entering into a
contract of sale with the third party, Ventas must first offer the Company the
right to purchase the leased property on substantially the same terms and
conditions as are contained in the third-party offer.
GOVERNMENTAL REGULATION
Medicare and Medicaid
Medicare is a federal program that provides certain hospital and medical
insurance benefits to persons age 65 and over and certain disabled persons.
Medicaid is a medical assistance program administered by each state pursuant to
which healthcare benefits are available to certain indigent patients. Within
the Medicare and Medicaid statutory framework, there are substantial areas
subject to administrative rulings, interpretations and discretion that may
affect payments made under Medicare and Medicaid. A substantial portion of the
Company's revenues are derived from patients covered by the Medicare and
Medicaid programs. See "--Health Services Division--Sources of Nursing Center
Revenues" and "--Hospital Division--Sources of Hospital Revenues."
Extensive Regulation
In the ordinary course of its business, the Company is subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
the Healthcare Regulations (as defined).
The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services (collectively, the
"Healthcare Regulations"). In addition, various laws including antikickback,
antifraud and abuse amendments codified under the Social Security Act (the
"Antikickback Amendments") prohibit certain business practices and
relationships that might affect the provisions and cost of healthcare services
reimbursable under Medicare and Medicaid, including the payment or receipt of
remuneration for the referral of patients whose care will be paid by Medicare
or other governmental programs. Sanctions for violating the Antikickback
Amendments include criminal penalties and civil sanctions, including fines and
possible exclusion from government programs such as the Medicare and Medicaid
programs.
The Department of Health and Human Services ("HHS") has issued regulations
that describe some of the conduct and business relationships permissible under
the Antikickback Amendments ("Safe Harbors"). The fact that a given business
arrangement does not fall within a Safe Harbor does not render the arrangement
per se illegal. Business arrangements of healthcare service providers that fail
to satisfy the applicable Safe Harbors criteria, however, risk increased
scrutiny and possible sanctions by enforcement authorities.
In addition, Section 1877 of the Social Security Act, which restricts
referrals by physicians of Medicare and other government-program patients to
providers of a broad range of designated health services with which they have
ownership or certain other financial arrangements, was amended effective
January 1, 1995, to broaden significantly the scope of prohibited physician
referrals under the Medicare and Medicaid programs to providers with which they
have ownership or certain other financial arrangements (the "Self-Referral
Prohibitions"). Many states have adopted or are considering similar legislative
proposals, some of which extend beyond the Medicaid program, to prohibit the
payment or receipt of remuneration for the referral of patients and physician
self-referrals regardless of the source of the payment for the care. These laws
and regulations are extremely complex and little judicial or regulatory
interpretation exists. The Company does not believe its arrangements are in
violation of the Self-Referral Prohibitions. There can be no assurance,
however, that governmental officials charged with responsibility for enforcing
the provisions of the Self-Referral Prohibitions will not assert that one or
more of the Company's arrangements are in violation of such provisions.
26
The Budget Act also provides a number of antifraud and abuse provisions. The
Budget Act contains additional civil monetary penalties for violations of the
Antikickback Amendments and imposes an affirmative duty on providers to ensure
that they do not employ or contract with persons excluded from the Medicare
program. The Budget Act also provides a minimum ten year period for exclusion
from participation in federal healthcare programs for persons or entities
convicted of a prior healthcare offense.
The Health Insurance Portability and Accountability Act of 1997 ("HIPAA"),
which became effective January 1, 1997, amends, among other things, Title XI
(42 U.S.C. (S)1301 et seq.) to broaden the scope of fraud and abuse laws to
include all health plans, whether or not they are reimbursed under federal
programs. In addition to broadening the scope of the fraud and abuse laws,
HIPAA also mandates the adoption of regulations aimed at: (a) standardizing
transaction formats and billing codes for documenting medical services and
dealing with claims submissions; and (b) protecting the privacy and security of
individually identifiable health information.
HIPAA regulations that standardize transactions and code sets became final in
the fourth quarter of 2000. Those regulations do not require healthcare
providers to submit claims electronically, but require standard formatting for
those that do. The Company currently submits its claims electronically and will
continue to do so. Therefore, the Company will be required to comply with HIPAA
transaction and code set standards by October 2002.
Final HIPAA privacy regulations were published in December 2000. Those
regulations apply to "protected health information," which is defined generally
as individually identifiable health information transmitted or maintained in
any form or medium, excluding certain education records and student medical
records. The privacy regulations seek to limit the use and disclosure of most
paper and oral communications, as well as those in electronic form, regarding
an individual's past, present or future physical or mental health or condition,
or relating to the provision of healthcare to the individual or payment for
that healthcare, if the individual can or may be identified by such
information. HIPAA provides for the imposition of civil or criminal penalties
if protected health information is improperly disclosed. The Company must
comply with the privacy regulations by April 2003.
HIPAA's security regulations have not yet been finalized. The proposed
security regulations specify administrative procedures, physical safeguards,
and technical services and mechanisms designed to ensure the privacy of
protected health information. The Company will be required to comply with the
security regulations 26 months after the regulations become final.
The Company is currently evaluating the impact of compliance with HIPAA
regulations, but it has not completed its analysis or finalized the estimated
costs to comply. There can be no assurances that the Company's compliance with
HIPAA regulations will not have an adverse affect on the Company's financial
position, results of operations or cash flows.
Some states require state approval for development and expansion of
healthcare facilities and services, including findings of need for additional
or expanded healthcare facilities or services. CONs, which are issued by
governmental agencies with jurisdiction over healthcare facilities, are at
times required for expansion of existing facilities, construction of new
facilities, addition of beds, acquisition of major items of equipment or
introduction of new services. The Company operates nursing centers in 22 states
and hospitals in 12 states that require state approval for the expansion of its
facilities and services under CON programs. There can be no assurance that the
Company will be able to obtain a CON for any or all future projects. If the
Company is unable to obtain the requisite CON, its growth and business could be
affected adversely.
The Company believes that the regulatory environment surrounding the long-
term care industry has intensified, particularly on large for-profit, multi-
facility providers. The federal government has imposed intensive enforcement
policies resulting in a significant increase in the number of inspections,
citations of regulatory deficiencies, and other regulatory sanctions including
terminations from the Medicare and Medicaid programs, bars on Medicare and
Medicaid payments for new admissions and civil monetary penalties. Such
27
sanctions can have a material adverse effect on the Company's results of
operations, liquidity and financial position. The Company vigorously contests
such sanctions, and in several cases has obtained injunctions against such
sanctions. While the Company generally has been successful to date in
contesting such sanctions, these cases involve significant legal expense and
the time of management and there can be no assurance that the Company will be
successful in the future.
In connection with the Government Settlement, the Company entered into the
Corporate Integrity Agreement. Under the Corporate Integrity Agreement, the
Company will implement a comprehensive internal quality improvement program and
a system of internal financial controls in its nursing centers and long-term
hospitals and its regional and corporate offices. The Corporate Integrity
Agreement is intended to promote compliance with the various healthcare
regulations applicable to the Company. The Corporate Integrity Agreement also
provides for third-party monitoring and reporting by the Company to the federal
government.
Health Services Division
The health services division is subject to various federal and state
regulations. In particular, the development and operation of nursing centers
and the provision of healthcare services are subject to federal, state and
local laws relating to the adequacy of medical care, equipment, personnel,
operating policies, fire prevention, rate-setting and compliance with building
codes and environmental laws. Nursing centers are subject to periodic
inspection by governmental and other authorities to assure continued compliance
with various standards, their continued licensing under state law,
certification under the Medicare and Medicaid programs and continued
participation in the Veterans Administration program. The failure to obtain,
retain or renew any required regulatory approvals or licenses could adversely
affect nursing center operations.
The nursing centers operated and managed by the health services division are
licensed either on an annual or bi-annual basis and generally are certified
annually for participation in Medicare and Medicaid programs through various
regulatory agencies which determine compliance with federal, state and local
laws. These legal requirements relate to the quality of the nursing care
provided, the qualifications of the administrative personnel and nursing staff,
the adequacy of the physical plant and equipment and continuing compliance with
the laws and regulations governing the operation of nursing centers. Federal
regulations affect the survey process for nursing centers and the authority of
state survey agencies and HCFA to impose sanctions on facilities based upon
noncompliance with certain requirements. Available sanctions include, but are
not limited to, imposition of civil monetary penalties, temporary suspension of
payment for new admissions, appointment of a temporary manager, suspension of
payment for eligible patients and suspension or decertification from
participation in the Medicare and Medicaid programs.
The Company believes that substantially all of its nursing centers currently
are in material compliance with applicable Medicare and Medicare requirements
of participation. In the ordinary course of business, however, the nursing
centers receive statements of deficiencies from regulatory agencies. In
response, the health services division will implement plans of correction to
address the alleged deficiencies. In most instances, the regulatory agency will
accept the facility's plan of correction and place the nursing center back into
compliance with regulatory requirements. In some cases or upon repeat
violations, the regulatory agency may take a number of adverse actions against
the nursing center. These adverse actions may include the imposition of fines,
temporary suspension of admission of new patients to the nursing center,
decertification from participation in the Medicaid and/or Medicare programs
and, in extreme circumstances, revocation of the nursing center's license.
The health services division also is subject to federal and state laws that
govern financial and other arrangements between healthcare providers. These
laws often prohibit certain direct and indirect payments or fee-splitting
arrangements between healthcare providers that are designed to induce or
encourage the referral of patients to, or the recommendation of, a particular
provider for medical products and services. Such laws include the Antikickback
Amendments. These provisions prohibit, among other things, the offer, payment,
solicitation or receipt of any form of remuneration in return for the referral
of Medicare and Medicaid patients. In addition, some states restrict certain
business relationships between physicians and pharmacies, and many
28
states prohibit business corporations from providing, or holding themselves out
as a provider of, medical care. Possible sanctions for violation of any of
these restrictions or prohibitions include loss of licensure or eligibility to
participate in reimbursement programs as well as civil and criminal penalties.
These laws vary from state to state.
In certain circumstances, federal law mandates that conviction for certain
abusive or fraudulent behavior with respect to one nursing center may subject
other facilities under common control or ownership to disqualification for
participation in Medicare and Medicaid programs. In addition, some regulations
provide that all nursing centers under common control or ownership within a
state are subject to delicensure if any one or more of such facilities are
delicensed.
Certificate of Need and State Licensing. CON regulations control the
development and expansion of healthcare services and facilities in certain
states. CON laws generally provide that approval must be obtained from the
designated state health planning agency prior to the expansion of existing
facilities, construction of new facilities, addition of beds, acquisition of
major items of equipment or introduction of new services. Certain states also
require regulatory approval prior to certain changes in ownership of a nursing
center. Certain states have eliminated their CON programs and other states are
considering alternatives to their CON programs. Of the 31 states in which the
Company's nursing centers are located as of December 31, 2000, Alabama,
Connecticut, Florida, Georgia, Kentucky, Louisiana, Maine, Massachusetts,
Mississippi, Montana, Nebraska, Nevada, New Hampshire, North Carolina, Ohio,
Oregon, Rhode Island, Tennessee, Vermont, Virginia, Washington and Wisconsin
have CON programs. To the extent that CONs or other similar approvals are
required for expansion of the operations of the health services division,
either through facility acquisitions, expansion or provision of new services or
other changes, such expansion could be affected adversely by the failure or
inability to obtain the necessary approvals, changes in the standards
applicable to such approvals or possible delays and expenses associated with
obtaining such approvals.
State licensing is a prerequisite to the operation of each nursing center and
to participation in government programs. Once a nursing center becomes licensed
and operational, it must continue to comply with federal, state and local
licensing requirements in addition to local building and life-safety codes. All
of the nursing centers operated by the health services division have obtained
the necessary licenses to conduct business.
Hospital Division
The hospital division is subject to various federal and state regulations. In
order to receive Medicare reimbursement, each hospital must meet the applicable
conditions of participation set forth by HHS relating to the type of hospital,
its equipment, personnel and standard of medical care, as well as comply with
state and local laws and regulations. The Company has developed a management
system to comply with the various standards and requirements. Each hospital
employs a person who is responsible for an ongoing quality assessment and
improvement program. Hospitals undergo periodic on-site Medicare certification
surveys, which generally are limited if the hospital is accredited by JCAHO. As
of December 31, 2000, all of the hospitals operated by the hospital division
were certified as Medicare providers and 54 of such hospitals also were
certified by their respective state Medicaid programs. A loss of certification
could affect adversely a hospital's ability to receive payments from the
Medicare and Medicaid programs.
Since 1983, Medicare has reimbursed general acute care hospitals under a
prospective payment system ("Hospital PPS"). Under Hospital PPS, Medicare
inpatient costs are reimbursed based upon a fixed payment amount per discharge
using diagnosis related groups ("DRG"). The DRG payment under Hospital PPS is
based upon the national average cost of treating a Medicare patient's
condition. Although the average length of stay varies for each DRG, the average
stay for all Medicare patients subject to Hospital PPS is approximately six
days. An additional outlier payment is made for patients with higher treatment
costs. Outlier payments are only designed to cover marginal costs.
Additionally, it takes 60 days or more for Hospital PPS payments to be made.
Accordingly, Hospital PPS creates an economic incentive for general short-term
acute care hospitals to discharge medically complex Medicare patients as soon
as clinically possible. Hospitals that are certified by Medicare as general
long-term hospitals are excluded from Hospital PPS. The Company believes that
the
29
incentive for short-term acute care hospitals to discharge medically complex
patients as soon as clinically possible creates a substantial referral source
for its long-term hospitals.
The Social Security Amendments of 1983 excluded certain hospitals including
general long-term hospitals from Hospital PPS. A general long-term hospital is
defined as a hospital that has an average length of stay greater than 25 days.
Inpatient operating costs for general long-term hospitals are reimbursed under
the cost-based reimbursement system, subject to a computed target rate (the
"Target") per discharge for inpatient operating costs established by TEFRA. As
discussed below, the Budget Act made significant changes to the TEFRA
provisions.
Prior to the Budget Act, Medicare operating costs per discharge in excess of
the Target were reimbursed at the rate of 50% of the excess up to 10% of the
Target. Hospitals whose operating costs were lower than the Target were
reimbursed their actual costs plus an incentive. This incentive was equal to
50% of the difference between their actual costs and the Target but may not
exceed 5% of the Target. For cost report periods beginning on or after October
1, 1997, the Budget Act reduced the incentive payments to an amount equal to
15% of the difference between the actual costs and the Target, but not to
exceed 2% of the Target. Costs in excess of the Target are still being
reimbursed at the rate of 50% of the excess up to 10% of the Target but the
threshold to qualify for such payments was raised from 100% to 110% of the
Target. The Budget Act also capped the Targets based on the 75th percentile for
each category of hospitals using 1996 data.
Prior to October 1, 1997, new hospitals could apply for an exemption from the
TEFRA Target provisions. For hospitals certified prior to October 1, 1992, the
exemption was optional and, if granted, lasted for three years. For
certifications since October 1, 1992, the exemption is automatic and is
effective for two years. Under the Budget Act, a new provider will no longer
receive unlimited cost-based reimbursement for its first few years in
operation. Instead, for the first two years, it will be paid the lower of its
costs or 110% of the median TEFRA Target for 1996 adjusted for inflation.
During this two-year period, providers remain subject to the TEFRA penalty and
incentive payments discussed in the previous paragraph.
As of December 31, 2000, 54 of the hospitals operated by the Company were
subject to TEFRA Target provisions. The reduction in TEFRA incentive payments
has had a material adverse effect on the hospital division's operating results.
These reductions, which began between May 1, 1998 and September 1, 1998 with
respect to the Company's hospitals, are expected to have a material adverse
impact on hospital revenues in the future and may impact adversely the
Company's ability to develop additional long-term care hospitals.
The Company also operates two general acute care hospitals that are subject
to Hospital PPS and are not subject to the TEFRA Target provisions.
Medicare and Medicaid reimbursements generally are determined from annual
cost reports filed by the Company, which are subject to audit by the respective
agency administering the programs. Management believes that adequate provisions
for loss have been recorded to reflect any adjustments that could result from
audits of these cost reports.
Federal regulations provide that admission to and utilization of hospitals by
Medicare and Medicaid patients must be reviewed by peer review organizations
("PROs") in order to ensure efficient utilization of hospitals and services. A
PRO may conduct such review either prospectively or retroactively and may, as
appropriate, recommend denial of payments for services provided to a patient.
Such review is subject to administrative and judicial appeal. Each of the
hospitals operated by the hospital division employs a clinical professional to
administer the hospital's integrated quality assurance and improvement program,
including its utilization review program. PRO denials have not had a material
adverse effect on the hospital division's operating results.
The Antikickback Amendments prohibit certain business practices and
relationships that might affect the provision and cost of healthcare services
reimbursable under federal healthcare programs. Sanctions for violating the
Antikickback Amendments include criminal and civil penalties and exclusion from
federal
30
healthcare programs. Pursuant to the Medicare and Medicaid Patient and Program
Protection Act of 1987, HHS and the OIG specified certain Safe Harbors that
describe conduct and business relationships permissible under the Antikickback
Amendments. These Safe Harbor regulations have resulted in more aggressive
enforcement of the Antikickback Amendments by HHS and the OIG.
Section 1877 of the Social Security Act (commonly known as "Stark I") states
that a physician who has a financial relationship with a clinical laboratory
generally is prohibited from referring patients to that laboratory. The Omnibus
Budget Reconciliation Act of 1993 contains provisions ("Stark II") amending
Section 1877 to expand greatly the scope of Stark I. Effective January 1995,
Stark II broadened the referral limitations of Stark I to include, among other
designated health services, inpatient and outpatient hospital services. Under
Stark I and Stark II (collectively referred to as the "Stark Provisions"), a
"financial relationship" is defined as an ownership interest or a compensation
arrangement. If such a financial relationship exists, the entity generally is
prohibited from claiming payment for such services under the Medicare or
Medicaid programs. Compensation arrangements generally are exempted from the
Stark Provisions if, among other things, the compensation to be paid is set in
advance, does not exceed fair market value and is not determined in a manner
that takes into account the volume or value of any referrals or other business
generated between the parties. These laws and regulations, however, are
extremely complex and the industry has the benefit of little judicial or
regulatory interpretation. The Company believes that business practices of
providers and financial relationships between providers have become subject to
increased scrutiny as healthcare reform efforts continue on the federal and
state levels.
The pharmacy operations within the hospital division are subject to
regulation by the various states in which business is conducted as well as by
the federal government. The pharmacies are regulated under the Food, Drug and
Cosmetic Act and the Prescription Drug Marketing Act, which are administered by
the United States Food and Drug Administration. Under the Comprehensive Drug
Abuse Prevention and Control Act of 1970, which is administered by the United
States Drug Enforcement Administration (the "DEA"), dispensers of controlled
substances must register with the DEA, file reports of inventories and
transactions and provide adequate security measures. Failure to comply with
such requirements could result in civil or criminal penalties.
JCAHO Accreditation. Hospitals receive accreditation from JCAHO, a nationwide
commission that establishes standards relating to the physical plant,
administration, quality of patient care and operation of medical staffs of
hospitals. Generally, hospitals and certain other healthcare facilities are
required to have been in operation at least six months in order to be eligible
for accreditation by JCAHO. After conducting on-site surveys, JCAHO awards
accreditation for up to three years to hospitals found to be in substantial
compliance with JCAHO standards. Accredited hospitals are periodically
resurveyed, at the option of JCAHO, upon a major change in facilities or
organization and after merger or consolidation. As of December 31, 2000, all of
the hospitals operated by the hospital division were accredited by JCAHO. The
hospital division intends to seek and obtain JCAHO accreditation for any
additional facilities it may purchase or lease and convert into long-term
hospitals. The hospital division does not believe that the failure to obtain
JCAHO accreditation at any hospital would have a material adverse effect on the
hospital division's results of operations.
State Regulatory Environment. The hospital division operates seven hospitals
in Florida, a state that regulates hospital rates. These operations contribute
a significant portion of the hospital division's revenues and operating income.
Accordingly, the hospital division's revenues and operating income could be
materially adversely affected by Florida rate setting laws or other cost
containment efforts. The hospital division also operates ten hospitals in
Texas, eight hospitals in California, and five hospitals in Illinois that
contribute a significant portion of its revenues and operating income. Although
Texas, California and Illinois do not currently regulate hospital rates, the
adoption of such legislation or other cost containment measures in these or
other states could have a material adverse effect on the hospital division's
revenues and operating income. The Company is unable to predict whether and in
what form such legislation may be adopted. Certain other states in which the
hospital division operates hospitals require disclosure of specified financial
information. The hospital division considers the regulatory environment,
including but not limited to, any mandated rate setting, in evaluating its
hospital operations.
31
Certificates of Need and State Licensing. Some states have amended their CON
regulations to require CON approval prior to the conversion of a hospital from
a general short-term facility to a general long-term facility. Of the 23 states
in which its hospitals were located as of December 31, 2000, Florida, Georgia,
Illinois, Kentucky, Massachusetts, Michigan, Missouri, Nevada, North Carolina,
Tennessee, Virginia and Washington have CON programs. With one exception, the
hospital division was not required to obtain a CON in connection with previous
acquisitions due to the relatively low renovation costs and the absence of the
need for additional licensed beds or changes in services. CONs may be required
in connection with the future hospital or services expansion of the hospital
division. There can be no assurance that the hospital division will be able to
obtain the CONs necessary for any or all future projects. If the hospital
division is unable to obtain the requisite CONs, its businesses could be
affected adversely.
State licensing of hospitals is a prerequisite to the operation of each
hospital and to participation in government programs. Once a hospital becomes
licensed and operational, it must continue to comply with federal, state and
local licensing requirements in addition to local building and life-safety
codes. All of the hospitals operated by the hospital division have obtained the
necessary licenses to conduct business.
Regulatory Changes
The Budget Act contained extensive changes to the Medicare and Medicaid
programs intended to reduce the projected amount of increase in payments under
those programs over a five year period. Virtually all spending reductions come
from reimbursements to providers and changes in program components. The Budget
Act has affected adversely the revenues in each of the Company's operating
divisions.
The Budget Act established PPS for nursing centers for cost reporting periods
beginning on or after July 1, 1998. While most nursing centers in the United
States became subject to PPS during the first quarter of 1999, all of the
Company's nursing centers adopted PPS on July 1, 1998. During the first three
years, the per diem rates for nursing centers are based on a blend of facility-
specific costs and federal costs. Thereafter, the per diem rates are based
solely on federal costs. The payments received under PPS cover all services for
Medicare patients including all ancillary services, such as respiratory
therapy, physical therapy, occupational therapy, speech therapy and certain
covered pharmaceuticals.
The Budget Act also reduced payments made to the hospitals operated by the
Company's hospital division by reducing TEFRA incentive payments, allowable
costs for capital expenditures and bad debts, and payments for services to
patients transferred from a general acute care hospital. The reductions in
allowable costs for capital expenditures became effective October 1, 1997. The
reductions in the TEFRA incentive payments and allowable costs for bad debts
became effective between May 1, 1998 and September 1, 1998. The reductions in
payments for services to patients transferred from a general acute care
hospital became effective October 1, 1998. These reductions have had a material
adverse impact on hospital revenues. In addition, these reductions also may
affect adversely the hospital division's ability to develop additional long-
term care hospitals in the future.
Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. As previously
discussed, Medicare reimbursements to nursing centers under PPS include
substantially all services provided to patients, including ancillary services.
Prior to the implementation of PPS, the costs of such services were reimbursed
under cost-based reimbursement rules. The decline in the demand for ancillary
services is mostly attributable to efforts by nursing centers to reduce
operating costs. As a result, many nursing centers are electing to provide
ancillary services to their patients through internal staff or are seeking
lower acuity patients who require less ancillary services. In response to PPS
and a significant decline in the demand for ancillary services, the Company
realigned its Vencare division in the fourth quarter of 1999 by integrating the
physical rehabilitation, speech and occupational therapy businesses into the
health services division and assigning the institutional pharmacy business to
the hospital division. Vencare's respiratory therapy and other ancillary
businesses were discontinued.
32
Since November 1999, various legislative and regulatory actions have provided
a measure of relief from some of the impact of the Budget Act. In November
1999, the Balanced Budget Refinement Act (the "BBRA") was enacted. Effective
April 1, 2000, the BBRA made a temporary 20% upward adjustment in the payment
rates for the care of higher acuity patients and allowed nursing centers to
transition more rapidly to the federal payment rates. The BBRA also imposed a
two-year moratorium on certain therapy limitations for skilled nursing center
patients covered under Medicare Part B. Effective October 1, 2000, the BBRA
increased all PPS payment categories by 4% for two years.
In April 2000, HCFA published a proposed rule which set forth updates to the
Resource Utilization Grouping ("RUG") payment rates used under PPS for nursing
centers. On July 31, 2000, HCFA issued a final rule that indefinitely postponed
any refinements to the RUG categories used under PPS. It also provided for the
continuance of Medicare payment relief set forth in the BBRA, including the 20%
upward adjustment for certain higher acuity RUG categories through September
30, 2001 and the scheduled 4% increase (effective October 2000) for all RUG
categories through September 30, 2002.
In December 2000, the Medicare, Medicaid, and State Child Health Insurance
Program Benefits Improvement and Protection Act of 2000 ("BIPA") was enacted to
provide up to $35 billion in additional funding to the Medicare and Medicaid
programs over the next five years. Under BIPA, the nursing component for each
RUG category will increase by 16.66% over the current rates for skilled nursing
care for the period April 1, 2001 through September 30, 2002. BIPA also will
provide some relief from scheduled reductions to the annual inflation
adjustments to the RUG payment rates through September 2001.
In addition, BIPA slightly increased payments for inpatient services and
TEFRA incentive payments for long-term acute care hospitals. Allowable costs
for bad debts also will be increased by 10%. Both of these provisions will
become effective for cost reporting periods beginning September 1, 2001.
Despite the recent legislation and regulatory actions discussed above,
Medicare revenues recorded under PPS in the Company's health services division
have been substantially less than the cost-based reimbursement it received
before the enactment of the Budget Act. In addition, the recent legislation did
not impact materially the reductions in Medicare revenues received by the
Company's hospitals as a result of the Budget Act.
There also continues to be state legislative proposals that would impose more
limitations on government and private payments to providers of healthcare
services such as the Company. By repealing the Boren Amendment, the Budget Act
eased existing impediments on the states' ability to reduce their Medicaid
reimbursement levels. Many states have enacted or are considering enacting
measures that are designed to reduce their Medicaid expenditures and to make
certain changes to private healthcare insurance. Some states also are
considering regulatory changes that include a moratorium on the designation of
additional long-term care hospitals. Regulatory changes in the Medicare and
Medicaid reimbursement systems applicable to the hospital division also are
being considered. There also are legislative proposals including cost caps and
the establishment of Medicaid prospective payment systems for nursing centers.
The Company could be affected adversely by the continuing efforts of
governmental and private third-party payors to contain the amount of
reimbursement for healthcare services. There can be no assurance that payments
under governmental and private third-party payor programs will remain at levels
comparable to present levels or will be sufficient to cover the costs allocable
to patients eligible for reimbursement pursuant to such programs. In addition,
there can be no assurance that facilities operated by the Company, or the
provision of services and supplies by the Company, will meet the requirements
for participation in such programs.
There can be no assurance that future healthcare legislation or other changes
in the administration or interpretation of governmental healthcare programs
will not have a material adverse effect on the Company's results of operations,
liquidity and financial position.
33
CORPORATE INTEGRITY AGREEMENT
In connection with the Government Settlement, the Company entered into a
Corporate Integrity Agreement with the OIG. Under the Corporate Integrity
Agreement, the Company will implement a comprehensive internal quality
improvement program and a system of internal financial controls in its nursing
centers and long-term hospitals and its regional and corporate offices.
The Company believes that the Corporate Integrity Agreement may differentiate
the Company's services and provide opportunities to promote strategic
objectives with regulators, government relations, labor unions and referral
sources. Under the Corporate Integrity Agreement, the Company has retained
flexibility to design and implement the agreement's requirements that have
enabled the Company to focus its efforts on developing improved systems and
processes of providing quality healthcare.
The Corporate Integrity Agreement will become effective on the effective date
of the Amended Plan and will apply to the Company and its subsidiaries and
managed entities. The Corporate Integrity Agreement also will apply to newly
acquired facilities after a phase-in period of six months.
As part of the Corporate Integrity Agreement, staff at the University of
Wisconsin's Center for Health Services Research and Analysis ("CHSRA"), will
assist in developing the internal quality improvement program. CHSRA also will
monitor and evaluate the Company's program and report its findings to the OIG.
The Corporate Integrity Agreement includes six components:
(1) The Company will adopt and implement written standards on federal
healthcare program requirements with respect to financial and quality of
care issues.
(2) The Company will conduct training each year for all employees to
promote compliance with federal healthcare requirements. Every employee
will undergo a minimum two hours of general compliance training annually.
At least two hours of specific training, tailored to issues affecting
employees with certain job responsibilities, also will be provided
annually, as well as a minimum of two hours of training for care-giving
employees focused on quality care. In addition, the Company will continue
to operate its internal compliance hotline.
(3) The Company will put in place a comprehensive internal quality
improvement program, which will include establishing committees at the
facility, regional and corporate levels to review quality-related data,
direct quality improvement activities and implement and monitor corrective
action plans. CHSRA will assist in program development and will evaluate
its integrity and effectiveness for the OIG.
(4) The Company will enhance its current system of internal financial
controls to promote compliance with federal healthcare program requirements
on billing and related financial issues, including a variety of internal
audit and compliance reviews. An independent review organization will be
retained to evaluate the integrity and effectiveness of the Company's
internal systems and will report annually its findings to the OIG.
(5) The Company will submit annual reports to the OIG demonstrating
compliance with the terms of the Corporate Integrity Agreement.
(6) The Corporate Integrity Agreement contains standard penalty
provisions for breach.
INFORMATION SYSTEMS
The Company's information systems strategy is focused on providing industry-
leading, value-added business solutions which will allow the Company to operate
efficiently and effectively under fixed reimbursement levels and increased
regulatory compliance requirements. Information systems activities are
determined by the operational strategies and priorities of each of the
Company's operating divisions.
34
Across the enterprise, the Company's integrated financial system, installed
in 1999, allows for timely monthly reporting of financial results. In addition,
extensive data warehouse capabilities across each operating division provide
the opportunity to present sophisticated clinical and financial management
reporting at a local, regional and enterprise level, enhancing the Company's
ability to manage operational performance. In 2000, a new integrated human
resources and payroll system was installed in all of the Company's hospitals
and the corporate office. Beginning in 2001, this system will begin to be
implemented in the Company's nursing centers.
New education tracking and event reporting systems were developed in 2000 to
support the Corporate Integrity Agreement. An internet-based distance learning
tool also was implemented in 2000, providing a cost-effective method to deliver
timely training to employees. Enterprise-wide access to various data through
internet-based solutions has improved operating efficiencies and reduced
administrative costs.
For the health services division, new information systems implemented in 2000
provide support for product line management and third-party reimbursement. The
resident care system is an internally developed business application that
captures patient assessment data to ensure that minimum data set assessment
forms are filed accurately and timely with reimbursement sources in each state.
The Company's clinical care management system blends clinical and financial
results within the Company's data warehouse to provide a decision support
platform for delivering high quality care in an economical manner. The
Company's quality reporting system, based on the industry-standard quality
indicators used by HCFA, allows each facility to monitor and manage the quality
of care being delivered. A new internet-based patient referral system is
enhancing the health services division's relationships with hospital discharge
planners by facilitating the search to locate appropriate nursing centers for
patients and automating the communication of critical patient data between the
discharging and admitting facilities.
The Company's hospitals utilize VenTouch(TM), an internally developed
electronic patient medical record system that was designed specifically for the
long-term acute care environment. VenTouch(TM) is a software application that
allows nurses, physicians and other clinicians to enter clinical information
during the patient care delivery process and view an online electronic patient
chart. In order to achieve compliance with the new regulations regarding
electronically transmitted health data imposed by HIPAA and improve integration
across all hospital patient care systems, the Company will be selecting and
piloting a new integrated patient care system in 2001. The new patient care
system will be integrated with the Company's billing and accounts receivable
system. The billing system, which was installed in all hospitals in 1999, has
resulted in improved accuracy and timeliness of accounts receivable collections
and reduced bad debts. The Company also developed and implemented new
information systems in 2000 to manage staffing levels and monitor quality
indicators at the facility, regional and corporate levels.
The Company's information systems architecture provides a reliable, scalable
infrastructure that is based on personal computers in the facilities connected
by a wide-area network to the Company's centralized data center in Louisville,
Kentucky. Enterprise systems management tools allow the Company to operate over
8,000 distributed personal computers and 600 centrally located servers on a
continuous basis.
ADDITIONAL INFORMATION
Employees
As of December 31, 2000, the Company had approximately 38,700 full-time and
13,200 part-time and per diem employees. The Company has approximately 2,300
unionized employees under 25 collective bargaining agreements as of December
31, 2000.
Due to nationwide low unemployment rates, the Company has experienced
difficulties in attracting and retaining qualified personnel, such as nurses,
certified nurse assistants, nurse's aides and other important providers of
healthcare. The Company's hospitals are particularly dependent on nurses for
patient care. The Company may experience increases in its labor costs primarily
due to higher wages and greater benefits
35
required to attract and retain qualified healthcare personnel. The Company's
ability to control labor costs, which represent the largest component of the
Company's operating expenses, will significantly impact its future operating
results.
Liability Insurance
The Company's healthcare operations are insured by the Company's wholly
owned captive insurance company, Cornerstone Insurance Company
("Cornerstone"). Cornerstone insures initial losses up to certain coverage
levels. Coverages for losses in excess of those insured by Cornerstone are
maintained through unrelated commercial insurance carriers.
The Company believes that its insurance is adequate in amount and coverage.
There can be no assurance that in the future such insurance will be available
at a reasonable price or that the Company will be able to maintain adequate
levels of professional liability insurance coverage.
CAUTIONARY STATEMENTS
This Annual Report on Form 10-K/A includes forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Exchange Act. All statements regarding the Company's
expected future financial position, results of operations, cash flows,
liquidity, financing plans, business strategy, budgets, projected costs and
capital expenditures, competitive position, growth opportunities, plans and
objectives of management for future operations and words such as "anticipate,"
"believe," "plan," "estimate," "expect," "intend," "may" and other similar
expressions are forward-looking statements. Such forward-looking statements
are inherently uncertain, and stockholders 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.
Actual future results and trends for the Company may differ materially
depending on a variety of factors discussed in this "Cautionary Statements"
section and elsewhere in this Annual Report on Form 10-K/A. Such forward-
looking statements are based on management's current expectations and include
known and unknown risks, uncertainties and other factors, many of which the
Company is unable to predict or control, that may cause the Company's actual
results or performance to differ materially from any future results or
performance expressed or implied by such forward-looking statements. Factors
that may affect the plans or results of the Company include, without
limitation, the following:
. the ability of the Company to continue as a going concern;
. delays or the inability to consummate the Amended Plan;
. the ability of the Company to make payments under the Amended Plan, if
consummated;
. the ability of the Company to successfully negotiate and execute the Exit
Facility;
. the ability of the Company to continue to operate pursuant to the terms
of the DIP Financing;
. the ability of the Company to operate successfully under the Chapter 11
Cases;
. risks associated with operating a business in Chapter 11;
. adverse actions which may be taken by creditors and the outcome of
various bankruptcy proceedings;
. adverse developments with respect to the Company's liquidity or results
of operations;
. the Company's ability to attract patients given its current financial
position;
. the ability of the Company to attract and retain key executives and other
healthcare personnel;
. the effects of healthcare reform and government regulations,
interpretation of regulations and changes in the nature and enforcement
of regulations governing the healthcare industry;
36
. changes in Medicare and Medicaid reimbursement rates;
. national and regional economic conditions, including their effect on the
availability and cost of labor, materials, and utilities;
. the Company's ability to control costs, including labor costs, in
response to the prospective payment system, implementation of the
Corporate Integrity Agreement and other regulatory actions;
. adverse developments with respect to the Company's settlement discussions
with the Government concerning ongoing investigations; and
. the dramatic increase in the costs of defending and insuring against
alleged patient care liability claims.
Many of these factors are beyond the control of the Company and its
management. The Company cautions investors that any forward-looking statements
made by the Company are not guarantees of future performance. The Company
disclaims any obligation to update any such factors or to announce publicly
the results of any revisions to any of the forward-looking statements to
reflect future events or developments.
Risks Associated with Potential Defaults under the DIP Financing
If the Company is unable to comply with the covenants contained in the DIP
Financing or is unable to obtain a waiver of any potential covenant violation,
a number of serious financial and operational difficulties may occur,
including the following:
. the Company's liquidity may be inadequate;
. the Company may be unable to make the required payments under the Master
Lease Agreements;
. the Company may be unable to repay amounts currently owed to third-party
payors including the Medicare program;
. the Company may be unable to invest adequate capital in its business to
maintain its current facilities;
. the focus of the Company's senior management may be diverted from
operational matters;
. the Company may be unable to attract and retain key executives and other
healthcare personnel;
. the Company may experience a reduction in the census at its nursing
centers and hospitals if patients and referral sources become concerned
about the Company's ability to provide quality care; and
. suppliers to the Company may stop providing supplies or services to the
Company or provide such supplies or services only on shortened payment or
cash terms.
These difficulties, if they were to occur, would have a material adverse
effect on the Company's liquidity, financial position and results of
operations. See "--Proceedings under Chapter 11 of the Bankruptcy Code" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Substantial Leverage and Ability to Meet Debt Service and Rent Requirements
The Company is highly leveraged and a substantial portion of its cash flow
from operations is dedicated to the payment of rents related to its leased
properties as well as principal and interest on outstanding indebtedness.
During the pendency of the Chapter 11 Cases, the Company is not paying
principal and interest on its Credit Agreement or the 1998 Notes. In
accordance with the Stipulation, the Company is obligated to make aggregate
monthly rent payments under the Master Lease Agreements of approximately $15.1
million. Under the HCFA Agreement, the Company is making monthly payments of
approximately $2.0 million to HCFA through March 2004.
The ability of the Company to service its financial obligations is dependent
upon, among other things, its ability to negotiate a sustainable capital
structure and improve its future financial performance. If the Company
37
is unable to generate sufficient funds to meet its obligations, the Company may
be required to refinance, restructure or otherwise amend some or all of such
obligations, sell assets or raise additional equity. There is no assurance that
such restructuring activities, sales of assets or issuances of equity can be
accomplished or, if accomplished, would raise sufficient funds to meet these
obligations. The Company's high degree of leverage and related financial
covenants also:
. require the Company to dedicate a substantial portion of its cash flow to
payments on its indebtedness, thereby reducing the availability of cash
flow to fund working capital, capital expenditures and other general
corporate activities;
. could have a material adverse effect on its ability to withstand
competitive pressures or adverse economic conditions (including adverse
regulatory changes);
. could affect adversely the Company's ability to make material
acquisitions, obtain future financing or take advantage of business
opportunities that may arise; and
. increase the Company's vulnerability to a downturn in general economic
conditions or in its businesses.
Potential Consequences of Failing to Pay Rent under Master Lease Agreements
In connection with the Chapter 11 Cases, the Company and Ventas entered into
the Stipulation which provides for the payment by the Company of a reduced
aggregate monthly rent of approximately $15.1 million. The Stipulation also
continues to toll any statutes of limitations or other time constraints in a
bankruptcy proceeding for claims that might be asserted by the Company against
Ventas. The Stipulation automatically renews for a one-month period unless
either party provides a 14-day notice of termination. The Stipulation also may
be terminated prior to its expiration upon a payment default by the Company,
the consummation of a plan of reorganization or the occurrence of certain
defaults under the DIP Financing. The Stipulation also provides that the
Company will continue to fulfill its indemnification obligations arising from
the Spin-off.
The Company's failure to pay the rent due or otherwise comply with the
Stipulation, in the absence of judicial relief, would result in an "Event of
Default" under the Master Lease Agreements. Upon an Event of Default under the
Master Lease Agreements, assuming Ventas were to be granted relief from the
automatic stay by the Bankruptcy Court, the remedies available to Ventas
include, without limitation, terminating the Master Lease Agreements,
repossessing and reletting the leased properties and requiring the Company to
(a) remain liable for all obligations under the Master Lease Agreements,
including the difference between the rent under the Master Lease Agreements and
the rent payable as a result of reletting the leased properties or (b) pay the
net present value of the rent due for the balance of the terms of the Master
Lease Agreements. Such remedies, however, would be subject to the supervision
of the Bankruptcy Court. See "--Proceedings under Chapter 11 of the Bankruptcy
Code" and "--Master Lease Agreements--Events of Default."
Healthcare Industry Risks
Dependence on Reimbursement Process; Medicare and Medicaid as Material Sources
of Revenues
The Company derives a substantial portion of its revenues from third-party
payors, including the Medicare and Medicaid programs. In 2000, the Company
derived approximately two-thirds of its total revenues from the Medicare and
Medicaid programs. Such programs are highly regulated and subject to frequent
and substantial changes. The Budget Act has reduced the projected increase in
Medicare payments and has made extensive changes in the Medicare and Medicaid
programs. In addition, private payors, including managed care payors,
increasingly are demanding discounted fee structures and the assumption by
healthcare providers of all or a portion of the financial risk. Efforts to
impose greater discounts and more stringent cost controls by private payors are
continuing.
38
Net revenue realizable under third-party payor agreements are subject to
change due to examination and retroactive adjustment by payors during the
settlement process. Payors may disallow in whole or in part requests for
reimbursement based on determinations that certain costs are not reimbursable
or reasonable or because additional supporting documentation is necessary. The
Company recognizes revenues from third-party payors and accrues estimated
settlement amounts in the period in which the related services are provided.
The Company estimates these settlement balances by making determinations based
on its prior settlement experience and its interpretation of the applicable
reimbursement rules and regulations.
In the hospital division, the Company has filed numerous collection actions
against insurers under Medicare supplement insurance policies to collect the
difference between what Medicare would have paid and the hospitals' usual and
customary charges. These disputes arise from differences in interpretation of
the policy provisions and certain federal and state laws governing such
policies. Various courts have issued various rulings on the different issues,
some of which have been adverse to the Company and most of which have been
appealed. See "Legal Proceedings."
There can be no assurances that adequate reimbursement levels will continue
to be available for the services provided by the Company which are currently
being reimbursed by Medicare, Medicaid or private payors. Significant limits on
the scope of services reimbursed and on reimbursement rates could have a
material adverse effect on the Company's liquidity, financial condition and
results of operations.
Increased Costs and Unpredictability of Patient Care Liability Claims
The Company, consistent with others in the long-term care industry, is
experiencing substantial increases in both the number and size of patient care
liability claims. In addition to compensatory damages, plaintiff attorneys are
increasingly seeking punitive damages and attorney's fees. As a result, general
and professional liability costs have become increasingly expensive and
unpredictable. If patient care liability claims continue to increase in number
and size, the Company's liquidity, financial condition and results of
operations could be materially adversely affected.
Availability of Healthcare Professionals
Due to nationwide low unemployment rates, the Company has experienced
difficulties in attracting and retaining qualified personnel, such as nurses,
certified nurse assistants, nurse's aides and other important providers of
healthcare. The Company's hospitals are particularly dependent on nurses for
patient care. The Company may experience increases in its labor costs primarily
due to higher wages and greater benefits required to attract and retain
qualified healthcare personnel. The Company's ability to control labor costs,
which represent the largest component of the Company's operating expenses, will
significantly impact its future operating results.
Extensive Regulation
In the ordinary course of its business, the Company is subject regularly to
inquiries, investigations and audits by federal and state agencies that oversee
the Healthcare Regulations. See "--Governmental Regulation."
The extensive federal, state and local regulations affecting the healthcare
industry include, but are not limited to, regulations relating to licensure,
conduct of operations, ownership of facilities, addition of facilities,
allowable costs, services and prices for services. In particular, the
Antikickback Amendments prohibit certain business practices and relationships
that might affect the provisions and cost of healthcare services reimbursable
under Medicare and Medicaid, including the payment or receipt of remuneration
for the referral of patients whose care will be paid by Medicare or other
governmental programs. Sanctions for violating the Antikickback Amendments
include criminal penalties and civil sanctions, including fines and possible
exclusion from government programs such as the Medicare and Medicaid programs.
In addition, Section 1877 of the Social Security Act, which restricts
referrals by physicians of Medicare and other government-program patients to
providers of a broad range of designated health services with which
39
they have ownership or certain other financial arrangements, was amended
effective January 1, 1995, to broaden significantly the scope of prohibited
physician referrals under the Medicare and Medicaid programs to providers with
which they have ownership or certain other financial arrangements. Many states
have adopted or are considering similar legislative proposals, some of which
extend beyond the Medicaid program, to prohibit the payment or receipt of
remuneration for the referral of patients and physician self-referrals
regardless of the source of the payment for the care. These laws and
regulations are extremely complex and little judicial or regulatory
interpretation exists. The Company does not believe its arrangements are in
violation of the Self-Referral Prohibitions. There can be no assurance,
however, that governmental officials charged with responsibility for enforcing
the provisions of the Self-Referral Prohibitions will not assert that one or
more of the Company's arrangements are in violation of such provisions.
The Budget Act also provides a number of antifraud and abuse provisions. The
Budget Act contains additional civil monetary penalties for violations of the
Antikickback Amendments and imposes an affirmative duty on providers to ensure
that they do not employ or contract with persons excluded from the Medicare
program. The Budget Act also provides a minimum ten year period for exclusion
from participation in federal healthcare programs for persons convicted of a
prior healthcare offense.
The Company believes that the regulatory environment surrounding the long-
term care industry has intensified, particularly on large for-profit, multi-
facility providers. The federal government has imposed intensive enforcement
policies resulting in a significant increase in the number of inspections,
citations of regulatory deficiencies, and other regulatory sanctions including
terminations from the Medicare and Medicaid programs, bars on Medicare and
Medicaid payments for new admissions and civil monetary penalties. Such
sanctions can have a material adverse effect on the Company's results of
operations, liquidity and financial position. The Company vigorously contests
such sanctions, and in several cases has obtained injunctions against such
sanctions. While the Company generally has been successful to date in
contesting such sanctions, these cases involve significant legal expense and
the time of management, and there can be no assurance that the Company will be
successful in the future.
In connection with the Government Settlement, the Company entered into the
Corporate Integrity Agreement. Under the Corporate Integrity Agreement, the
Company will implement a comprehensive internal quality improvement program and
a system of internal financial controls in its nursing centers and long-term
hospitals and its regional and corporate offices. The Corporate Integrity
Agreement is intended to promote compliance with various healthcare regulations
applicable to the Company. The Corporate Integrity Agreement also provides for
third-party monitoring and reporting by the Company to the federal government.
The Company is unable to predict the future course of federal, state and
local regulation or legislation, including Medicare and Medicaid statutes and
regulations or the intensity of federal and state enforcement actions. Changes
in the regulatory framework and sanctions from various enforcement actions
could have a material adverse effect on the Company's liquidity, financial
condition and results of operations.
Regulatory Changes
The Budget Act contained extensive changes to the Medicare and Medicaid
programs intended to reduce the projected amount of increase in payments under
those programs over a five year period. Virtually all spending reductions come
from reimbursements to providers and changes in program components. The Budget
Act has affected adversely the revenues in each of the Company's operating
divisions.
The Budget Act established PPS for nursing centers for cost reporting periods
beginning on or after July 1, 1998. While most nursing centers in the United
States became subject to PPS during the first quarter of 1999, all of the
Company's nursing centers adopted PPS on July 1, 1998. During the first three
years, the per diem rates for nursing centers are based on a blend of facility-
specific costs and federal costs. Thereafter, the per
40
diem rates are based solely on federal costs. The payments received under PPS
cover all services for Medicare patients including all ancillary services, such
as respiratory therapy, physical therapy, occupational therapy, speech therapy
and certain covered pharmaceuticals.
The Budget Act also reduced payments made to the hospitals operated by the
Company's hospital division by reducing TEFRA incentive payments, allowable
costs for capital expenditures and bad debts, and payments for services to
patients transferred from a general acute care hospital. The reductions in
allowable costs for capital expenditures became effective October 1, 1997. The
reductions in the TEFRA incentive payments and allowable costs for bad debts
became effective between May 1, 1998 and September 1, 1998. The reductions in
payments for services to patients transferred from a general acute care
hospital became effective October 1, 1998. These reductions have had a material
adverse impact on hospital revenues. In addition, these reductions also may
affect adversely the hospital division's ability to develop additional long-
term care hospitals in the future.
Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. As previously
discussed, Medicare reimbursements to nursing centers under PPS include
substantially all services provided to patients, including ancillary services.
Prior to the implementation of PPS, the costs of such services were reimbursed
under cost-based reimbursement rules. The decline in the demand for ancillary
services is mostly attributable to efforts by nursing centers to reduce
operating costs. As a result, many nursing centers are electing to provide
ancillary services to their patients through internal staff or are seeking
lower acuity patients who require less ancillary services. In response to PPS
and a significant decline in the demand for ancillary services, the Company
realigned its Vencare division in the fourth quarter of 1999 by integrating the
physical rehabilitation, speech and occupational therapy businesses into the
health services division and assigning the institutional pharmacy business to
the hospital division. Vencare's respiratory therapy and other ancillary
businesses were discontinued.
Since November 1999, various legislative and regulatory actions have provided
a measure of relief from some of the impact of the Budget Act. In November
1999, the BBRA was enacted. Effective April 1, 2000, the BBRA made a temporary
20% upward adjustment in the payment rates for the care of higher acuity
patients and allowed nursing centers to transition more rapidly to the federal
payment rates. The BBRA also imposed a two-year moratorium on certain therapy
limitations for skilled nursing center patients covered under Medicare Part B.
Effective October 1, 2000, the BBRA increased all PPS payment categories by 4%
for two years.
In April 2000, HCFA published a proposed rule which set forth updates to the
RUG payment rates used under PPS for nursing centers. On July 31, 2000, HCFA
issued a final rule that indefinitely postponed any refinements to the RUG
categories used under PPS. It also provided for the continuance of Medicare
payment relief set forth in the BBRA, including the 20% upward adjustment for
certain higher acuity RUG categories through September 30, 2001 and the
scheduled 4% increase (effective October 2000) for all RUG categories through
September 30, 2002.
In December 2000, BIPA was enacted to provide up to $35 billion in additional
funding to the Medicare and Medicaid programs over the next five years. Under
BIPA, the nursing component for each RUG category will increase by 16.66% over
the current rates for skilled nursing care for the period April 1, 2001 through
September 30, 2002. BIPA also will provide some relief from scheduled
reductions to the annual inflation adjustments to the RUG payment rates through
September 2001.
In addition, BIPA slightly increased payments for inpatient services and
TEFRA incentive payments for long-term acute care hospitals. Allowable costs
for bad debts also will be increased by 10%. Both of these provisions will
become effective for cost reporting periods beginning September 1, 2001.
Despite the recent legislation and regulatory actions discussed above,
Medicare revenues recorded under PPS in the Company's health services division
have been substantially less than the cost-based reimbursement it received
before the enactment of the Budget Act. In addition, the recent legislation did
not impact materially the reductions in Medicare revenues received by the
Company's hospitals as a result of the Budget Act.
41
There also continues to be state legislative proposals that would impose more
limitations on government and private payments to providers of healthcare
services such as the Company. By repealing the Boren Amendment, the Budget Act
eased existing impediments on the states' ability to reduce their Medicaid
reimbursement levels. Many states have enacted or are considering enacting
measures that are designed to reduce their Medicaid expenditures and to make
certain changes to private healthcare insurance. Some states also are
considering regulatory changes that include a moratorium on the designation of
additional long-term care hospitals. Regulatory changes in the Medicare and
Medicaid reimbursement systems applicable to the hospital division also are
being considered. There also are legislative proposals including cost caps and
the establishment of Medicaid prospective payment systems for nursing centers.
The Company could be affected adversely by the continuing efforts of
governmental and private third-party payors to contain the amount of
reimbursement for healthcare services. There can be no assurance that payments
under governmental and private third-party payor programs will remain at levels
comparable to present levels or will be sufficient to cover the costs allocable
to patients eligible for reimbursement pursuant to such programs. In addition,
there can be no assurance that facilities operated by the Company, or the
provision of services and supplies by the Company, will meet the requirements
for participation in such programs.
There can be no assurance that future healthcare legislation or other changes
in the administration or interpretation of governmental healthcare programs
will not have a material adverse effect on the Company's results of operations,
liquidity and financial position.
Risks Relating to State Regulation
The Company operates seven hospitals in Florida, a state which regulates
hospital rates. These operations contribute a significant portion of the
Company's revenues and operating income from its hospital division.
Accordingly, the Company's hospital revenues and operating income could be
materially adversely affected by Florida rate setting laws or other cost
containment efforts. The Company also operates ten hospitals in Texas, eight
hospitals in California, and five hospitals in Illinois which contribute a
significant portion of the Company's revenues and operating income. Although
Texas, California and Illinois do not currently regulate hospital rates, the
adoption of such legislation or other cost containment measures in these or
other states could have a material adverse effect on the hospital division's
revenues and operating income. The Company is unable to predict whether and in
what form such legislation may be adopted. There can be no assurance that
future healthcare legislation or other changes in the administration or
interpretation of governmental healthcare programs will not have a material
adverse effect on the Company's results of operations, liquidity and financial
position.
Highly Competitive Industry
The long-term healthcare services industry is highly competitive. The
Company's nursing centers compete on a local and regional basis with other
nursing centers and other long-term healthcare providers. Some facilities
operated by the Company's competitors are located in newer facilities and may
offer services not provided by the Company or are operated by entities having
greater financial and other resources than the Company. The Company's hospitals
face competition from general acute care hospitals and long-term care hospitals
which provide services comparable to those offered by the Company's hospitals.
Many general acute care hospitals and long-term hospitals are larger and more
established than the Company's hospitals. The Company may experience increased
competition from existing hospitals as well as hospitals converted, in whole or
in part, to specialized care facilities. The long-term care industry is divided
into a variety of competitive areas which market similar services. These
competitors include nursing centers, hospitals, extended care centers, assisted
living facilities, home health agencies and similar institutions. The Company's
facilities generally operate in communities that also are served by similar
facilities operated by its competitors. Certain of the Company's competitors
are operated by not-for-profit, nontaxpaying or governmental agencies, which
can finance capital expenditures on a tax-exempt basis, and which receive funds
and charitable contributions unavailable to the Company. The Company's
facilities compete based on factors such as its reputation for quality care;
the commitment and expertise of its staff and physicians; the quality and
comprehensiveness of its treatment programs; charges for services; and the
physical appearance, location and condition of its facilities.
42
The Company also competes with other companies in providing rehabilitation
therapy services and institutional pharmacy services. Many of these competing
companies have greater financial and other resources than the Company. There
can be no assurance that increased competition in the future will not adversely
affect the Company's financial condition and results of operations.
Item 2. Properties
For information concerning the nursing centers and hospitals operated by the
Company, see "Business--Health Services Division--Nursing Center Facilities,"
"Business--Hospital Division--Hospital Facilities," and "Business--Master Lease
Agreements." The Company believes that its facilities are adequate for the
Company's future needs in such locations.
In December 1998, the Company purchased an approximately 287,000 square foot
building located in Louisville, Kentucky as its corporate headquarters to
consolidate corporate employees from several locations.
Item 3. Legal Proceedings
Summary descriptions of various significant legal and regulatory activities
follow.
On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 Cases have been styled In re: Vencor, Inc., et al.,
Debtors and Debtors in Possession, Case Nos. 99-3199 (MFW) through 99-3327
(MFW), Chapter 11, Jointly Administered. On December 14, 2000, the Company
filed its Amended Plan with the Bankruptcy Court. On March 1, 2001, the
Bankruptcy Court approved the Company's Amended Plan and an order was entered
confirming the Amended Plan on March 16, 2001. See "Business--Proceedings under
Chapter 11 of the Bankruptcy Code" for further discussion of the Chapter 11
Cases.
On March 18, 1999, the Company served Ventas with a demand for mediation
pursuant to the Spin-off Agreement. The Company was seeking a reduction in rent
and other concessions under its Master Lease Agreements with Ventas. On March
31, 1999, the Company and Ventas entered into a standstill agreement which
provided that both companies would postpone through April 12, 1999 any claims
either may have against the other. On April 12, 1999, the Company and Ventas
entered into a second standstill which provided that neither party would pursue
any claims against the other or any other third party related to the Spin-off
as long as the Company complied with certain rent payment terms. The second
standstill was scheduled to terminate on May 5, 1999. Pursuant to a tolling
agreement, the Company and Ventas also agreed that any statutes of limitations
or other time-related constraints in a bankruptcy or other proceeding that
might be asserted by one party against the other would be extended and tolled
from April 12, 1999 until May 5, 1999 or until the termination of the second
standstill. As a result of the Company's failure to pay rent, Ventas served the
Company with notices of nonpayment under the Master Lease Agreements.
Subsequently, the Company and Ventas entered into further amendments to the
second standstill and the tolling agreement to extend the time during which no
remedies may be pursued by either party and to extend the date by which the
Company may cure its failure to pay rent.
In connection with the Chapter 11 Cases, the Company and Ventas entered into
the Stipulation that provides for the payment by the Company of a reduced
aggregate monthly rent of approximately $15.1 million. The Stipulation has been
approved by the Bankruptcy Court. The Stipulation also continues to toll any
statutes of limitations or other time constraints in a bankruptcy proceeding
for claims that might be asserted by the Company against Ventas. The
Stipulation automatically renews for one-month periods unless either party
provides a 14-day notice of termination. The Stipulation also may be terminated
prior to its expiration upon a payment default by the Company, the consummation
of a plan of reorganization or the occurrence of certain defaults under the DIP
Financing. The Stipulation also provides that the Company will continue to
fulfill its indemnification obligations arising from the Spin-off. The
Stipulation will terminate upon the effective date of the Amended Plan.
The Company believes that the Amended Plan, if consummated, will resolve all
material disputes between the Company and Ventas. The Amended Plan also
provides for comprehensive mutual releases between the Company and Ventas,
other than for obligations that the Company is assuming under the Amended Plan.
43
If the Amended Plan does not become effective and the Company and Ventas are
unable to otherwise resolve their disputes or maintain an interim resolution,
the Company may seek to pursue claims against Ventas arising out of the Spin-
off and seek judicial relief barring Ventas from exercising any remedies based
on the Company's failure to pay some or all of the rent to Ventas. The
Company's failure to pay rent or otherwise comply with the Stipulation, in the
absence of judicial relief, would result in an "Event of Default" under the
Master Lease Agreements. Upon an Event of Default under the Master Lease
Agreements, assuming Ventas were to be granted relief from the automatic stay
by the Bankruptcy Court, the remedies available to Ventas include, without
limitation, terminating the Master Lease Agreements, repossessing and reletting
the leased properties and requiring the Company to (a) remain liable for all
obligations under the Master Lease Agreements, including the difference between
the rent under the Master Lease Agreements and the rent payable as a result of
reletting the leased properties or (b) pay the net present value of the rent
due for the balance of the terms of the Master Lease Agreements. Such remedies,
however, would be subject to the supervision of the Bankruptcy Court.
The Company's subsidiary, formerly named TheraTx, Incorporated, is plaintiff
in a declaratory judgment action entitled TheraTx, Incorporated v. James W.
Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States District
Court for the Northern District of Georgia and currently pending in the United
States Court of Appeals for the Eleventh Circuit, No. 99-11451-FF. The
defendants have asserted counterclaims against TheraTx under breach of
contract, securities fraud, negligent misrepresentation and other fraud
theories for allegedly not performing as promised under a merger agreement
related to TheraTx's purchase of a company called PersonaCare, Inc. and for
allegedly failing to inform the defendants/counterclaimants prior to the merger
that TheraTx's possible acquisition of Southern Management Services, Inc. might
cause the suspension of TheraTx's shelf registration under relevant rules of
the Securities and Exchange Commission (the "Commission"). The court granted
summary judgment for the defendants/counterclaimants and ruled that TheraTx
breached the shelf registration provision in the merger agreement, but
dismissed the defendants' remaining counterclaims. Additionally, the court
ruled after trial that defendants/counterclaimants were entitled to damages and
prejudgment interest in the amount of approximately $1.3 million and attorneys'
fees and other litigation expenses of approximately $700,000. The Company and
the defendants/counterclaimants both appealed the court's rulings. The Court of
Appeals for the Eleventh Circuit affirmed the trial court's rulings with the
exception of the damages award and certified the question of the proper
calculation of damages under Delaware law to the Delaware Supreme Court. The
Company is defending the action vigorously.
The Company is pursuing various claims against private insurance companies
who issued Medicare supplement insurance policies to individuals who became
patients of the Company's hospitals. After the patients' Medicare benefits are
exhausted, the insurance companies become liable to pay the insureds' bills
pursuant to the terms of these policies. The Company has filed numerous
collection actions against various of these insurers to collect the difference
between what Medicare would have paid and the hospitals' usual and customary
charges. These disputes arise from differences in interpretation of the policy
provisions and federal and state laws governing such policies. Various courts
have issued various rulings on the different issues, some of which have been
adverse to the Company and most of which have been appealed. The Company
intends to continue to pursue these claims vigorously. If the Company does not
prevail on these issues, future results of operations and liquidity would be
materially adversely affected.
A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al., was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The class action claims
were brought by an alleged stockholder of the Company's predecessor against the
Company and Ventas and certain current and former executive officers and
directors of the Company and Ventas. The complaint alleges that the Company,
Ventas and certain current and former executive officers of the Company and
Ventas during a specified time frame violated Sections 10(b) and 20(a) of the
Exchange Act, by, among other things, issuing to the investing public a series
of false and misleading statements concerning Ventas' then current operations
and the inherent value of its common stock. The complaint further alleges that
as a result of these purported false and misleading statements concerning
Ventas' revenues and successful acquisitions, the price of the common stock was
artificially inflated. In particular, the complaint alleges that the defendants
44
issued false and misleading financial statements during the first, second and
third calendar quarters of 1997 which misrepresented and understated the impact
that changes in Medicare reimbursement policies would have on Ventas' core
services and profitability. The complaint further alleges that the defendants
issued a series of materially false statements concerning the purportedly
successful integration of Ventas' acquisitions and prospective earnings per
share for 1997 and 1998 which the defendants knew lacked any reasonable basis
and were not being achieved. The suit seeks damages in an amount to be proven
at trial, pre-judgment and post-judgment interest, reasonable attorneys' fees,
expert witness fees and other costs, and any extraordinary equitable and/or
injunctive relief permitted by law or equity to assure that the plaintiff has
an effective remedy. In December 1998, the defendants filed a motion to dismiss
the case. The court converted the defendants' motion to dismiss into a motion
for summary judgment and granted summary judgment as to all defendants. The
plaintiff appealed the ruling to the United States Court of Appeals for the
Sixth Circuit. On April 24, 2000, the Sixth Circuit affirmed the district
court's dismissal of the action on the grounds that the plaintiff failed to
state a claim upon which relief could be granted. On July 14, 2000, the Sixth
Circuit granted the plaintiff's petition for a rehearing en banc. The Company
is defending this action vigorously.
A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed in June 1998 in the Jefferson County, Kentucky, Circuit Court. The suit
was brought on behalf of the Company and Ventas against certain current and
former executive officers and directors of the Company and Ventas. The
complaint alleges that the defendants damaged the Company and Ventas by
engaging in violations of the securities laws, engaging in insider trading,
fraud and securities fraud and damaging the reputation of the Company and
Ventas. The plaintiff asserts that such actions were taken deliberately, in bad
faith and constitute breaches of the defendants' duties of loyalty and due
care. The complaint is based on substantially similar assertions to those made
in the class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al.,
discussed above. The suit seeks unspecified damages, interest, punitive
damages, reasonable attorneys' fees, expert witness fees and other costs, and
any extraordinary equitable and/or injunctive relief permitted by law or equity
to assure that the Company and Ventas have an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends to
defend this action vigorously.
A class action lawsuit entitled Jules Brody v. Transitional Hospitals
Corporation, et al., Case No. CV-S-97-00747-PMP, was filed on June 19, 1997 in
the United States District Court for the District of Nevada on behalf of a
class consisting of all persons who sold shares of Transitional common stock
during the period from February 26, 1997 through May 4, 1997, inclusive. The
complaint alleges that Transitional purchased shares of its common stock from
members of the investing public after it had received a written offer to
acquire all of the Transitional common stock and without making the required
disclosure that such an offer had been made. The complaint further alleges that
defendants disclosed that there were "expressions of interest" in acquiring
Transitional when, in fact, at that time, the negotiations had reached an
advanced stage with actual firm offers at substantial premiums to the trading
price of Transitional's stock having been made which were actively being
considered by Transitional's Board of Directors. The complaint asserts claims
pursuant to Sections 10(b), 14(e) and 20(a) of the Exchange Act, and common law
principles of negligent misrepresentation and names as defendants Transitional
as well as certain former senior executives and directors of Transitional. The
plaintiff seeks class certification, unspecified damages, attorneys' fees and
costs. In June 1998, the court granted the Company's motion to dismiss with
leave to amend the Section 10(b) claim and the state law claims for
misrepresentation. The court denied the Company's motion to dismiss the Section
14(e) and Section 20(a) claims, after which the Company filed a motion for
reconsideration. On March 23, 1999, the court granted the Company's motion to
dismiss all remaining claims and the case was dismissed. The plaintiff has
appealed this ruling to the United States Court of Appeals for the Ninth
Circuit. The Company is defending this action vigorously.
On April 14, 1999, a lawsuit entitled Lenox Healthcare, Inc., et al. v.
Vencor, Inc., et al., Case No. BC 208750, was filed in the Superior Court of
Los Angeles, California by Lenox Healthcare, Inc. ("Lenox") asserting various
causes of action arising out of the Company's sale and lease of several nursing
centers to Lenox in 1997. Lenox subsequently removed certain of its causes of
action and refiled these claims before the
45
United States District Court for the Western District of Kentucky in a case
entitled Lenox Healthcare, Inc. v. Vencor, Inc., et al., Case No. 3:99 CV-348-
H. The Company asserted counterclaims, including RICO claims, against Lenox in
the Kentucky action. The Company believes that the allegations made by Lenox in
both complaints are without merit. Lenox and its subsidiaries filed for
protection under Chapter 11 of the Bankruptcy Code on November 3, 1999. By
virtue of both the Company's and Lenox's separate filings for Chapter 11
protection, the two Lenox actions and the Company's counterclaims were stayed.
Subsequently, the parties entered into a settlement, which was approved by
their respective bankruptcy courts, that requires the dismissal of the two
above actions. Joint motions to dismiss have been filed by the parties in each
court.
The Company was informed by the DOJ that the Company and Ventas are the
subjects of investigations into various Medicare reimbursement issues,
including hospital cost reporting issues, Vencare billing practices and various
quality of care issues in the hospitals and nursing centers formerly operated
by Ventas and currently operated by the Company. These investigations include
some matters for which the Company indemnified Ventas in the Spin-off. In cases
where neither the Company nor any of its subsidiaries are defendants but Ventas
is the defendant, the Company had agreed to defend and indemnify Ventas for
such claims as part of the Spin-off. The Stipulation entered into with Ventas
provides that the Company will continue to fulfill its indemnification
obligations arising from the Spin-off. The Company has cooperated fully in the
investigations.
The DOJ has informed the Company that it has intervened in several pending
qui tam actions asserted against the Company and/or Ventas in connection with
these investigations. In addition, the DOJ has filed proofs of claims with
respect to certain alleged claims in the Chapter 11 Cases. The Company, Ventas
and the DOJ have finalized the terms of the Government Settlement which will
resolve all of the DOJ investigations including the pending qui tam actions.
The Government Settlement provides that within 30 days after the Amended Plan
becomes effective, the Government will move to dismiss with prejudice to the
United States and the relators (except for certain claims which will be
dismissed without prejudice to the United States in certain of the cases) the
pending qui tam actions as against any or all of the Company and its
subsidiaries, Ventas and any current or former officers, directors and
employees of either entity. There can be no assurance that each court before
which a qui tam action is pending will dismiss the case on the DOJ's motion.
For a summary of the terms of the Government Settlement contained in the
Amended Plan, see "Business--Proceedings under Chapter 11 of the Bankruptcy
Code."
The following is a summary of the qui tam actions pending against the Company
and/or Ventas in which the DOJ has intervened. In connection with the DOJ's
intervention, the courts ordered these previously non-public actions to be
unsealed. Certain of the actions described below name other defendants in
addition to the Company and Ventas.
(a) The Company, Ventas and the Company's subsidiary, American X-Rays,
Inc. ("AXR"), are defendants in a civil qui tam action styled United States
ex rel. Doe v. American X-Rays Inc., et al., No. LR-C-95-332, pending in
the United States District Court for the Eastern District of Arkansas and
served on AXR on July 7, 1997. The DOJ intervened in the suit which was
brought under the Federal Civil False Claims Act and added the Company and
Ventas as defendants. The Company acquired an interest in AXR when
Hillhaven was merged into the Company in September 1995 and purchased the
remaining interest in AXR in February 1996. AXR provided portable X-ray
services to nursing centers (including some of those operated by Ventas or
the Company) and other healthcare providers. The civil suit alleges that
AXR submitted false claims to the Medicare and Medicaid programs. The suit
seeks damages in an amount of not less than $1,000,000, treble damages and
civil penalties. The Company has defended this action vigorously. The court
has dismissed the action based upon the possible pending settlement between
the DOJ, the Company and Ventas. In a related criminal investigation, the
United States Attorney's Office for the Eastern District of Arkansas
("USAO") indicted four former employees of AXR; those individuals were
convicted of various fraud related counts in January 1999. AXR had been
informed previously that it was not a target of the criminal investigation,
and AXR was not indicted. However, the Company received several grand jury
subpoenas for documents and witnesses which it moved to quash. The USAO has
withdrawn the subpoenas which rendered the motion moot.
46
(b) The Company's subsidiary, Medisave Pharmacies, Inc. ("Medisave"),
Ventas and Hillhaven (former parent company to Medisave), are the
defendants in a civil qui tam action styled United States ex rel. Danley v.
Medisave Pharmacies, Inc., et al., No. CV-N-96-00170-HDM, filed in the
United States District Court for the District of Nevada on March 15, 1996.
The plaintiff alleges that Medisave, an institutional pharmacy provider,
formerly owned by Ventas and owned by the Company since the Spin-off: (a)
charged the Medicare program for unit dose drugs when bulk drugs were
administered and charged skilled nursing facilities more for the same drugs
for Medicare patients than for non-Medicare patients; (b) improperly
claimed special dispensing fees that it was not entitled to under Medicaid;
and (c) recouped unused drugs from skilled nursing facilities and returned
these drugs to its stock without crediting Medicare or Medicaid, all in
violation of the Federal Civil False Claims Act. The complaint also alleges
that Medisave had a policy of offering kickbacks, such as free equipment,
to skilled nursing centers to secure and maintain their business. The
complaint seeks treble damages, other unspecified damages, civil penalties,
attorneys' fees and other costs. The Company disputes the allegations in
the complaint. The defendants intend to defend this action vigorously.
(c) Ventas and the Company's subsidiary, Vencare, Inc. ("Vencare"), among
others, are defendants in the action styled United States ex rel. Roberts
v. Vencor, Inc., et al., No. 3:97CV-349-J, filed in the United States
District Court for the Western District of Kansas on June 25, 1996 and
consolidated with the action styled United States of America ex rel.
Meharg, et al. v. Vencor, Inc., et al., No. 3:98SC-737-H, filed in the
United States District Court for the Middle District of Florida on June 4,
1998. The complaint alleges that the defendants knowingly submitted and
conspired to submit false claims and statements to the Medicare program in
connection with their purported provision of respiratory therapy services
to skilled nursing center residents. The defendants allegedly billed
Medicare for respiratory therapy services and supplies when those services
were not medically necessary, billed for services not provided, exaggerated
the time required to provide services or exaggerated the productivity of
their therapists. It is further alleged that the defendants presented false
claims and statements to the Medicare program in violation of the Federal
Civil False Claims Act, by, among other things, allegedly causing skilled
nursing centers with which they had respiratory therapy contracts, to
present false claims to Medicare for respiratory therapy services and
supplies. The complaint seeks treble damages, other unspecified damages,
civil penalties, attorneys' fees and other costs. The Company disputes the
allegations in the complaint. The defendants intend to defend this action
vigorously.
(d) In United States ex rel. Kneepkens v. Gambro Healthcare, Inc., et
al., No. 97-10400-GAO, filed in the United States District Court for the
District of Massachusetts on October 15, 1998, the Company's subsidiary,
Transitional, and two unrelated entities, Gambro Healthcare, Inc. and
Dialysis Holdings, Inc., are defendants in this suit alleging that they
violated the Federal Civil False Claims Act and the Medicare and Medicaid
antikickback, antifraud and abuse regulations and committed common law
fraud, unjust enrichment and payment by mistake of fact. Specifically, the
complaint alleges that a predecessor to Transitional formed a joint venture
with Damon Clinical Laboratories to create and operate a clinical testing
laboratory in Georgia that was then used to provide lab testing for
dialysis patients, and that the joint venture billed at below cost in
return for referral of substantially all non-routine testing in violation
of Medicare and Medicaid antikickback and antifraud regulations. It is
further alleged that a predecessor to Transitional and Damon Clinical
Laboratories used multiple panel testing of end stage renal disease rather
than single panel testing that allegedly resulted in the generation of
additional revenues from Medicare and that the entities allegedly added
non-routine tests to tests otherwise ordered by physicians that were not
requested or medically necessary but resulted in additional revenue from
Medicare in violation of the antikickback and antifraud regulations.
Transitional has moved to dismiss the case. Transitional disputes the
allegations in the complaint and is defending the action vigorously.
(e) The Company and/or Ventas are defendants in the action styled United
States ex rel. Huff and Dolan v. Vencor, Inc., et al., No. 97-4358 AHM
(Mcx), filed in the United States District Court for the Central District
of California on June 13, 1997. The plaintiff alleges that the defendant
violated the Federal Civil False Claims Act by submitting false claims to
the Medicare, Medicaid and CHAMPUS
47
programs by allegedly: (a) falsifying patient bills and submitting the
bills to the Medicare, Medicaid and CHAMPUS programs, (b) submitting bills
for intensive and critical care not actually administered to patients, (c)
falsifying patient charts in relation to the billing, (d) charging for
physical therapy services allegedly not provided and pharmacy services
allegedly provided by non-pharmacists, and (e) billing for sales calls made
by nurses to prospective patients. The complaint seeks treble damages,
other unspecified damages, civil penalties, attorneys' fees and other
costs. Defendants dispute the allegations in the complaint. The Company, on
behalf of itself and Ventas, intends to defend this action vigorously.
(f) Ventas is the defendant in the action styled United States ex rel.
Brzycki v. Vencor, Inc., Civ. No. 97-451-JD, filed in the United States
District Court for the District of New Hampshire on September 8, 1997.
Ventas is alleged to have knowingly violated the Federal Civil False Claims
Act by submitting and conspiring to submit false claims to the Medicare
program. The complaint alleges that Ventas: (a) fabricated diagnosis codes
by ordering medically unnecessary services, such as respiratory therapy;
(b) changed referring physicians' diagnoses in order to qualify for
Medicare reimbursement; and (c) billed Medicare for oxygen use by patients
regardless of whether the oxygen was actually administered to particular
patients. The complaint further alleges that Ventas paid illegal kickbacks
to referring healthcare professionals in the form of medical consulting
service agreements as an alleged inducement to refer patients, in violation
of the Federal Civil False Claims Act, the antikickback and antifraud
regulations and the Stark provisions. It is additionally alleged that
Ventas consistently submitted Medicare claims for clinical services that
were not performed or were performed at lower actual costs. The complaint
seeks unspecified damages, civil penalties, attorneys' fees and costs.
Ventas disputes the allegations in the complaint. The Company, on behalf of
Ventas, intends to defend the action vigorously.
(g) United States ex rel. Lanford and Cavanaugh v. Vencor, Inc., et al.,
Civ. No. 97-CV-2845, was filed against Ventas in the United States District
Court for the Middle District of Florida, on November 24, 1997. The United
States of America intervened in this civil qui tam lawsuit on May 17, 1999.
On July 23, 1999, the United States filed its amended complaint in the
lawsuit and added the Company as a defendant. The lawsuit alleges that the
Company and Ventas knowingly submitted false claims and false statements to
the Medicare and Medicaid programs including, but not limited to, claims
for reimbursement of costs for certain ancillary services performed in
defendants' nursing centers and for third-party nursing center operators
that the United States alleges are not properly reimbursable costs through
the hospitals' cost reports. The lawsuit involves the Company's hospitals
which were owned by Ventas prior to the Spin-off. The complaint does not
specify the amount of damages sought. The Company and Ventas dispute the
allegations in the amended complaint and intend to defend this action
vigorously.
(h) In United States ex rel. Harris and Young v. Vencor, Inc., et al.,
filed in the Eastern District of Missouri on May 25, 1999, the defendants
include the Company, Vencare, and Ventas. The defendants allegedly
submitted and conspired to submit false claims for payment to the Medicare
and CHAMPUS programs, in violation of the Federal Civil False Claims Act.
According to the complaint, the Company, through its subsidiary, Vencare,
allegedly (a) over billed for respiratory therapy services, (b) rendered
medically unnecessary treatment, and (c) falsified supply, clinical and
equipment records. The defendants also allegedly encouraged or instructed
therapists to falsify clinical records and over prescribe therapy services.
The complaint seeks treble damages, other unspecified damages, civil
penalties, attorneys' fees and other costs. The Company disputes the
allegations in the complaint and intends to defend this action vigorously.
The action has been dismissed with prejudice as to the relator and without
prejudice as to the United States.
(i) In United States ex rel. George Mitchell, et al. v. Vencor, Inc., et
al., filed in the United States District Court for the Southern District of
Ohio on August 13, 1999, the defendants, consisting of the Company and its
two subsidiaries, Vencare and Vencor Hospice, Inc., are alleged to have
violated the Federal Civil False Claims Act by obtaining improper
reimbursement from Medicare concerning the treatment of hospice patients.
Defendants are alleged to have obtained inflated Medicare reimbursement for
admitting, treating and/or failing to discharge in a timely manner hospice
patients who were not "hospice appropriate." The complaint further alleges
that the defendants obtained inflated reimbursement
48
for providing medications for these hospice patients. The complaint alleges
damages in excess of $1,000,000. The Company disputes the allegations in
the complaint and intends to defend vigorously the action.
(j) In Gary Graham, on Behalf of the United States of America v. Vencor
Operating, Inc. et. al., filed in the United States District Court for the
Southern District of Florida on or about June 8, 1999, the defendants,
including the Company, its subsidiary, Vencor Operating, Inc., Ventas,
Hillhaven and Medisave, are alleged to have presented or caused to be
presented false or fraudulent claims for payment to the Medicare program in
violation of, among other things, the Federal Civil False Claims Act. The
complaint alleges that Medisave, a subsidiary of the Company which was
transferred from Ventas to the Company in the Spin-off, systematically up-
charged for drugs and supplies dispensed to Medicare patients. The
complaint seeks unspecified damages, civil penalties, interest, attorneys'
fees and other costs. The Company disputes the allegations in the complaint
and intends to defend this action vigorously.
(k) In United States, et al., ex rel. Phillips-Minks, et al. v.
Transitional Corp., et al., filed in the United States District Court for
Southern District of California on July 23, 1998, the defendants, including
Transitional and Ventas, are alleged to have submitted and conspired to
submit false claims and statements to Medicare, Medicaid, and other federal
and state funded programs during a period commencing in 1993. The conduct
complained of allegedly violates the Federal Civil False Claims Act, the
California False Claims Act, the Florida False Claims Act, the Tennessee
Health Care False Claims Act, and the Illinois Whistleblower Reward and
Protection Act. The defendants allegedly submitted improper and erroneous
claims to Medicare, Medicaid and other programs, for improper or
unnecessary services and services not performed, inadequate collections
efforts associated with billing and collecting bad debts, inflated and
nonexistent laboratory charges, false and inadequate documentation of
claims, splitting charges, shifting revenues and expenses, transferring
patients to hospitals that are reimbursed by Medicare at a higher level,
failing to return duplicate reimbursement payments, and improperly
allocating hospital insurance expenses. In addition, the complaint alleges
that the defendants were inconsistent in their reporting of cost report
data, paid kickbacks to increase patient referrals to hospitals, and
incorrectly reported employee compensation resulting in inflated employee
401(k) contributions. The complaint seeks unspecified damages. The Company
disputes the allegations in the complaint and intends to defend this action
vigorously.
In connection with the Spin-off, liabilities arising from various legal
proceedings and other actions were assumed by the Company and the Company
agreed to indemnify Ventas against any losses, including any costs or expenses,
it may incur arising out of or in connection with such legal proceedings and
other actions. The indemnification provided by the Company also covers losses,
including costs and expenses, which may arise from any future claims asserted
against Ventas based on the former healthcare operations of Ventas. In
connection with its indemnification obligation, the Company has assumed the
defense of various legal proceedings and other actions. The Stipulation entered
into with Ventas provides that the Company will continue to fulfill its
indemnification obligations arising from the Spin-off.
The Company is a party to certain legal actions and regulatory investigations
arising in the normal course of its business. The Company is unable to predict
the ultimate outcome of pending litigation and regulatory investigations. In
addition, there can be no assurance that the DOJ, HCFA or other regulatory
agencies will not initiate additional investigations related to the Company's
businesses in the future, nor can there be any assurance that the resolution of
any litigation or investigations, either individually or in the aggregate,
would not have a material adverse effect on the Company's results of
operations, liquidity or financial position. In addition, the above litigation
and investigations (as well as future litigation and investigations) are
expected to consume the time and attention of the Company's management and may
have a disruptive effect upon the Company's operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable.
49
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
MARKET PRICE FOR COMMON STOCK
AND DIVIDEND HISTORY
Since March 17, 2000, the Company's common stock has traded on the OTC
Bulletin Board under the symbol "VCRIQ." The common stock traded on the OTC
Bulletin Board under the symbol "VCRI" from June 10, 1999 until March 16, 2000.
The common stock previously traded on the New York Stock Exchange ("NYSE")
under the ticker symbol of "VC" until June 7, 1999. The number of shareholders
of record on February 28, 2001 was 4,310. The prices in the table below, for
the calendar quarters indicated, represent the high and low sales prices for
the common stock as reported by the OTC Bulletin Board and the NYSE Composite
Tape, as applicable, during 1999 and 2000. No cash dividends have been paid on
the common stock during such periods.
Dividends cannot be declared on the Company's stock under the terms of the
DIP Financing.
Sales Price
of Common
Stock
-----------
High Low
----- -----
1999
----
First Quarter....................................................... $5.00 $0.81
Second Quarter...................................................... 1.13 0.13
Third Quarter....................................................... 0.26 0.06
Fourth Quarter...................................................... 0.27 0.07
2000
----
First Quarter....................................................... $0.24 $0.11
Second Quarter...................................................... 0.13 0.07
Third Quarter....................................................... 0.13 0.07
Fourth Quarter...................................................... 0.09 0.03
50
Item 6. Selected Financial Data
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc.)
SELECTED FINANCIAL DATA
AS OF AND FOR THE YEARS ENDED DECEMBER 31
(In thousands, except for per share amounts and statistics)
(Restated)
-------------------------------------
2000 1999 1998 1997 1996
----------- ----------- ----------- ----------- -----------
Statement of Operations
Data:
Revenues................ $ 2,888,542 $ 2,665,641 $ 2,999,739 $ 3,116,004 $ 2,577,783
----------- ----------- ----------- ----------- -----------
Salaries, wages and
benefits............... 1,623,955 1,566,227 1,753,023 1,788,053 1,490,938
Supplies................ 374,540 347,789 340,053 347,127 303,463
Rent.................... 307,809 305,120 234,144 89,474 77,795
Other operating
expenses............... 503,770 964,413 947,889 446,340 489,155
Depreciation and
amortization........... 73,545 93,196 124,617 123,865 99,533
Interest expense........ 60,431 80,442 107,008 102,736 45,922
Investment income....... (5,393) (5,188) (4,688) (6,057) (12,203)
----------- ----------- ----------- ----------- -----------
2,938,657 3,351,999 3,502,046 2,891,538 2,494,603
----------- ----------- ----------- ----------- -----------
Income (loss) before
reorganization costs
and income taxes....... (50,115) (686,358) (502,307) 224,466 83,180
Reorganization costs.... 12,636 18,606 - - -
----------- ----------- ----------- ----------- -----------
Income (loss) before
income taxes........... (62,751) (704,964) (502,307) 224,466 83,180
Provision for income
taxes.................. 2,000 500 76,099 89,338 35,175
----------- ----------- ----------- ----------- -----------
Income (loss) from
operations............. (64,751) (705,464) (578,406) 135,128 48,005
Cumulative effect of
change in accounting
for start-up costs..... - (8,923) - - -
Extraordinary loss on
extinguishment of debt,
net of income taxes.... - - (77,937) (4,195) -
----------- ----------- ----------- ----------- -----------
Net income (loss)...... $ (64,751) $ (714,387) $ (656,343) $ 130,933 $ 48,005
=========== =========== =========== =========== ===========
Earnings (loss) per
common share:
Basic:
Income (loss) from
operations............ $ (0.94) $ (10.03) $ (8.47) $ 1.96 $ 0.69
Cumulative effect of
change in accounting
for start-up costs.... - (0.13) - - -
Extraordinary loss on
extinguishment of
debt.................. - - (1.14) (0.06) -
----------- ----------- ----------- ----------- -----------
Net income (loss)...... $ (0.94) $ (10.16) $ (9.61) $ 1.90 $ 0.69
=========== =========== =========== =========== ===========
Diluted:
Income (loss) from
operations............ $ (0.94) $ (10.03) $ (8.47) $ 1.92 $ 0.68
Cumulative effect of
change in accounting
for start-up costs.... - (0.13) - - -
Extraordinary loss on
extinguishment of
debt.................. - - (1.14) (0.06) -
----------- ----------- ----------- ----------- -----------
Net income (loss)...... $ (0.94) $ (10.16) $ (9.61) $ 1.86 $ 0.68
=========== =========== =========== =========== ===========
Shares used in computing
earnings (loss) per
common share:
Basic.................. 70,229 70,406 68,343 68,938 69,704
Diluted................ 70,229 70,406 68,343 70,359 70,702
Financial Position:
Working capital
(deficit).............. $ 267,161 $ 195,011 $ (682,569) $ 431,113 $ 316,615
Assets.................. 1,334,414 1,235,974 1,774,372 3,334,739 1,968,856
Long-term debt.......... - - 6,600 1,919,624 710,507
Long-term debt in
default classified as
current................ - - 760,885 - -
Liabilities subject to
compromise............. 1,260,373 1,159,417 - - -
Stockholders' equity
(deficit).............. (471,734) (406,022) 307,747 905,350 797,091
Operating Data:
Number of nursing
centers:
Owned or leased........ 278 282 278 296 297
Managed................ 34 13 13 13 16
Number of nursing center
licensed beds:
Owned or leased........ 36,466 36,912 36,701 38,694 37,444
Managed................ 3,723 1,661 1,661 1,689 2,175
Number of nursing center
patient days (a)....... 11,580,295 11,656,439 11,939,266 12,622,238 12,566,763
Nursing center occupancy
% (a).................. 86.1 86.8 87.3 90.5 91.9
Number of hospitals..... 56 56 57 60 38
Number of hospital
licensed beds.......... 4,886 4,931 4,979 5,273 3,325
Number of hospital
patient days........... 1,044,663 982,301 947,488 767,810 586,144
Hospital occupancy %.... 60.8 56.9 54.0 52.9 53.7
--------
(a) Excludes managed facilities.
51
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Selected Financial Data in Item 6 and the consolidated financial
statements included herein set forth certain data with respect to the financial
position, results of operations and cash flows of the Company which should be
read in conjunction with the following discussion and analysis.
As discussed in the Notes to the Consolidated Financial Statements, the
Company realigned its Vencare ancillary services business in the fourth quarter
of 1999. Vencare's physical rehabilitation, speech and occupational therapies
were integrated into the Company's health services division, and its
institutional pharmacy business was assigned to the hospital division.
Vencare's respiratory therapy and certain other ancillary businesses were
discontinued. Financial and operating data presented in Item 6 and the
following discussion and analysis reflect the realignment of the former Vencare
businesses for all periods presented.
The consolidated financial statements have been prepared on the basis of
accounting principles applicable to going concerns and contemplate the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. The consolidated financial statements do not include
any adjustments that might result from the resolution of the Chapter 11 Cases
or other matters discussed herein.
General
The Company provides long-term healthcare services primarily through the
operation of nursing centers and hospitals. At December 31, 2000, the Company's
health services division operated 312 nursing centers (40,189 licensed beds) in
31 states and a rehabilitation therapy business. The Company's hospital
division operated 56 hospitals (4,886 licensed beds) in 23 states and an
institutional pharmacy business.
Reorganization. On September 13, 1999, the Company and substantially all of
its subsidiaries filed voluntary petitions for protection under Chapter 11 of
the Bankruptcy Code. The Company currently is operating its businesses as a
debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. The
Company's recent operating losses, liquidity issues and the Chapter 11 Cases
raise substantial doubt about the Company's ability to continue as a going
concern. The ability of the Company to continue as a going concern and the
appropriateness of using the going concern basis of accounting are dependent
upon, among other things, (a) the Company's ability to comply with the terms of
the DIP Financing, (b) consummation of the Amended Plan, (c) the Company's
ability to achieve profitable operations after such consummation, and (d) the
Company's ability to generate sufficient cash from operations to meet its
obligations. The Amended Plan and other actions during the Chapter 11 Cases
could change materially the amounts currently recorded in the consolidated
financial statements. See Note 3 of the Notes to Consolidated Financial
Statements.
Spin-off. On May 1, 1998, Ventas completed the Spin-off through the
distribution of Vencor common stock to its stockholders. Ventas retained
ownership of substantially all of its real property and leases such real
property to the Company under the Master Lease Agreements. In anticipation of
the Spin-off, the Company was incorporated on March 27, 1998. For accounting
purposes, the consolidated historical financial statements of Ventas became the
Company's historical financial statements following the Spin-off. Any
discussion concerning events prior to May 1, 1998 refers to the Company's
business as it was conducted by Ventas prior to the Spin-off.
52
Results of Operations
A summary of key operating data follows (dollars in thousands):
Year Ended December 31,
-------------------------------------
2000 1999 1998
----------- ----------- -----------
Revenues:
Health services division:
Nursing centers........................ $ 1,675,627 $ 1,594,244 $ 1,667,343
Rehabilitation services................ 135,036 195,731 264,574
Other ancillary services............... - 43,527 168,165
Elimination............................ (77,191) (128,267) (124,500)
----------- ----------- -----------
1,733,472 1,705,235 1,975,582
Hospital division:
Hospitals.............................. 1,007,947 850,548 919,847
Pharmacy............................... 204,252 171,493 149,991
----------- ----------- -----------
1,212,199 1,022,041 1,069,838
----------- ----------- -----------
2,945,671 2,727,276 3,045,420
Elimination of pharmacy charges to
Company nursing centers................ (57,129) (61,635) (45,681)
----------- ----------- -----------
$ 2,888,542 $ 2,665,641 $ 2,999,739
=========== =========== ===========
Income (loss) from operations
(restated):
Operating income (loss):
Health services division:
Nursing centers........................ $ 278,738 $ 169,128 $ 213,036
Rehabilitation services................ 8,047 2,891 18,398
Other ancillary services............... 4,737 4,166 30,183
----------- ----------- -----------
291,522 176,185 261,617
Hospital division:
Hospitals.............................. 205,858 132,050 247,272
Pharmacy............................... 7,421 342 15,301
----------- ----------- -----------
213,279 132,392 262,573
Corporate overhead..................... (113,823) (108,947) (126,291)
Unusual transactions................... (4,701) (412,418) (439,125)
Reorganization costs................... (12,636) (18,606) -
----------- ----------- -----------
Operating income (loss)............... 373,641 (231,394) (41,226)
Rent.................................... (307,809) (305,120) (234,144)
Depreciation and amortization........... (73,545) (93,196) (124,617)
Interest, net........................... (55,038) (75,254) (102,320)
----------- ----------- -----------
Loss before income taxes................ (62,751) (704,964) (502,307)
Provision for income taxes.............. 2,000 500 76,099
----------- ----------- -----------
$ (64,751) $ (705,464) $ (578,406)
=========== =========== ===========
Nursing center data:
Revenue mix %:
Medicare............................... 27.9 26.1 29.3
Medicaid............................... 48.8 48.7 44.7
Private and other...................... 23.3 25.2 26.0
Patient days:
Medicare............................... 1,541,934 1,436,288 1,498,968
Medicaid............................... 7,735,567 7,718,963 7,746,401
Private and other...................... 2,302,794 2,501,188 2,693,897
----------- ----------- -----------
11,580,295 11,656,439 11,939,266
=========== =========== ===========
Average daily census.................... 31,640 31,935 32,710
Occupancy %............................. 86.1 86.8 87.3
Hospital data:
Revenue mix %:
Medicare............................... 55.1 58.3 58.5
Medicaid............................... 10.3 10.5 9.7
Private and other...................... 34.6 31.2 31.8
Patient days:
Medicare............................... 704,152 669,976 647,283
Medicaid............................... 134,754 119,849 121,538
Private and other...................... 205,757 192,476 178,667
----------- ----------- -----------
1,044,663 982,301 947,488
=========== =========== ===========
Average daily census.................... 2,854 2,691 2,596
Occupancy %............................. 60.8 56.9 54.0
53
Regulatory Changes
The Budget Act contained extensive changes to the Medicare and Medicaid
programs intended to reduce the projected amount of increase in payments under
those programs over a five year period. Virtually all spending reductions come
from reimbursements to providers and changes in program components. The Budget
Act has affected adversely the revenues in each of the Company's operating
divisions.
The Budget Act established PPS for nursing centers for cost reporting periods
beginning on or after July 1, 1998. While most nursing centers in the United
States became subject to PPS during the first quarter of 1999, all of the
Company's nursing centers adopted PPS on July 1, 1998. During the first three
years, the per diem rates for nursing centers are based on a blend of facility-
specific costs and federal costs. Thereafter, the per diem rates are based
solely on federal costs. The payments received under PPS cover all services for
Medicare patients including all ancillary services, such as respiratory
therapy, physical therapy, occupational therapy, speech therapy and certain
covered pharmaceuticals.
The Budget Act also reduced payments made to the hospitals operated by the
Company's hospital division by reducing TEFRA incentive payments, allowable
costs for capital expenditures and bad debts, and payments for services to
patients transferred from a general acute care hospital. The reductions in
allowable costs for capital expenditures became effective October 1, 1997. The
reductions in the TEFRA incentive payments and allowable costs for bad debts
became effective between May 1, 1998 and September 1, 1998. The reductions in
payments for services to patients transferred from a general acute care
hospital became effective October 1, 1998. These reductions have had a material
adverse impact on hospital revenues. In addition, these reductions also may
affect adversely the hospital division's ability to develop additional long-
term care hospitals in the future.
Under PPS, the volume of ancillary services provided per patient day to
nursing center patients also has declined dramatically. As previously
discussed, Medicare reimbursements to nursing centers under PPS include
substantially all services provided to patients, including ancillary services.
Prior to the implementation of PPS, the costs of such services were reimbursed
under cost-based reimbursement rules. The decline in the demand for ancillary
services is mostly attributable to efforts by nursing centers to reduce
operating costs. As a result, many nursing centers are electing to provide
ancillary services to their patients through internal staff or are seeking
lower acuity patients who require less ancillary services. In response to PPS
and a significant decline in the demand for ancillary services, the Company
realigned its Vencare division in the fourth quarter of 1999 by integrating the
physical rehabilitation, speech and occupational therapy businesses into the
health services division and assigning the institutional pharmacy business to
the hospital division. Vencare's respiratory therapy and other ancillary
businesses were discontinued.
Since November 1999, various legislative and regulatory actions have provided
a measure of relief from some of the impact of the Budget Act. In November
1999, the BBRA was enacted. Effective April 1, 2000, the BBRA made a temporary
20% upward adjustment in the payment rates for the care of higher acuity
patients and allowed nursing centers to transition more rapidly to the federal
payment rates. The BBRA also imposed a two-year moratorium on certain therapy
limitations for skilled nursing center patients covered under Medicare Part B.
Effective October 1, 2000, the BBRA increased all PPS payment categories by 4%
for two years.
In April 2000, HCFA published a proposed rule which set forth updates to the
RUG payment rates used under PPS for nursing centers. On July 31, 2000, HCFA
issued a final rule that indefinitely postponed any refinements to the RUG
categories used under PPS. It also provided for the continuance of Medicare
payment relief set forth in the BBRA, including the 20% upward adjustment for
certain higher acuity RUG categories through September 30, 2001 and the
scheduled 4% increase (effective October 2000) for all RUG categories through
September 30, 2002.
In December 2000, BIPA was enacted to provide up to $35 billion in additional
funding to the Medicare and Medicaid programs over the next five years. Under
BIPA, the nursing component for each RUG category will increase by 16.66% over
the current rates for skilled nursing care for the period April 1, 2001 through
54
September 30, 2002. BIPA also will provide some relief from scheduled
reductions to the annual inflation adjustments to the RUG payment rates
through September 2001.
In addition, BIPA slightly increased payments for inpatient services and
TEFRA incentive payments for long-term acute care hospitals. Allowable costs
for bad debts also will be increased by 10%. Both of these provisions will
become effective for cost reporting periods beginning September 1, 2001.
Despite the recent legislation and regulatory actions discussed above,
Medicare revenues recorded under PPS in the Company's health services division
have been substantially less than the cost-based reimbursement it received
before the enactment of the Budget Act. In addition, the recent legislation
did not impact materially the reductions in Medicare revenues received by the
Company's hospitals as a result of the Budget Act.
There also continues to be state legislative proposals that would impose
more limitations on government and private payments to providers of healthcare
services such as the Company. By repealing the Boren Amendment, the Budget Act
eased existing impediments on the states' ability to reduce their Medicaid
reimbursement levels. Many states have enacted or are considering enacting
measures that are designed to reduce their Medicaid expenditures and to make
certain changes to private healthcare insurance. Some states also are
considering regulatory changes that include a moratorium on the designation of
additional long-term care hospitals. Regulatory changes in the Medicare and
Medicaid reimbursement systems applicable to the hospital division also are
being considered. There also are legislative proposals including cost caps and
the establishment of Medicaid prospective payment systems for nursing centers.
The Company could be affected adversely by the continuing efforts of
governmental and private third-party payors to contain the amount of
reimbursement for healthcare services. There can be no assurance that payments
under governmental and private third-party payor programs will remain at
levels comparable to present levels or will be sufficient to cover the costs
allocable to patients eligible for reimbursement pursuant to such programs. In
addition, there can be no assurance that facilities operated by the Company,
or the provision of services and supplies by the Company, will meet the
requirements for participation in such programs.
There can be no assurance that future healthcare legislation or other
changes in the administration or interpretation of governmental healthcare
programs will not have a material adverse effect on the Company's results of
operations, liquidity and financial position.
Health Services Division--Nursing Centers
Revenues increased 5% in 2000 to $1.68 billion. Substantially all of the
increase was attributable to increased Medicare and Medicaid funding and price
increases to private payors. Medicaid and private payor rates both increased
approximately 5% in 2000 compared to 1999. Medicare revenues per patient day
grew 5% to $303 in 2000 from $290 in 1999 primarily as a result of
reimbursement increases associated with the BBRA. As previously discussed, the
BBRA established, among other things, a 20% increase in Medicare payment rates
for higher acuity patients effective April 1, 2000 and a 4% increase in all
PPS payment categories effective October 1, 2000. As result of the phase-in of
the provisions of the BBRA, Medicare revenues per patient day in the fourth
quarter of 2000 averaged $321 or 10% higher than the same period in 1999.
Revenues declined 4% in 1999 to $1.59 billion. Medicaid rates increased
approximately 5% in 1999 compared to 1998, while private payor rates were
relatively unchanged. As previously discussed, all of the Company's nursing
centers adopted PPS on July 1, 1998, resulting in substantially less Medicare
reimbursement to the Company's nursing centers. Average Medicare revenues per
patient day in 1999 declined 11% from $326 in 1998. Lower average Medicare
reimbursement rates in 1999 resulted primarily from the full-year effect of
PPS.
Same-store patient days were relatively unchanged during the last three
years. Management believes that the Chapter 11 Cases have had little, if any,
impact on nursing center patient days.
55
Nursing center operating income in 2000 totaled $279 million compared to $169
million in 1999. A substantial portion of the improvement resulted from
operating efficiencies related to the fourth quarter 1999 Vencare realignment
and growth in revenues. In addition, the provision for doubtful accounts
declined in 2000 to $23 million from $51 million last year as a result of
improved collection processes.
Nursing center operating income in 1999 declined 21% from $213 million in
1998. The decline was primarily attributable to reductions in Medicare
reimbursement under PPS. While the Company achieved some operating efficiencies
in 1999 in response to PPS, expenses related to professional liability risks
and doubtful accounts increased substantially. Professional liability costs
aggregated $45 million in 1999 compared to $18 million in 1998, while costs for
doubtful accounts increased to $51 million in 1999 from $17 million in 1998.
Health Services Division--Rehabilitation Services
Revenues declined 31% in 2000 to $135 million and 26% in 1999 to $196
million. Revenue declines in both periods were primarily attributable to
reduced customer demand for ancillary services in response to fixed
reimbursement rates under PPS and the elimination of unprofitable external
contracts. Approximately one-half of the revenue decline in 2000 was
attributable to Company-operated nursing centers. Under PPS, the reimbursement
for ancillary services provided to nursing center patients is a component of
the total reimbursement allowed per nursing center patient. As a result, many
nursing center customers (including the Company's nursing centers) have elected
to provide ancillary services to their patients through internal staff and no
longer contract with outside parties for ancillary services.
Rehabilitation services reported operating income of $8 million in 2000
compared to $3 million in 1999 and $18 million in 1998. Operating results for
both 2000 and 1999 were adversely impacted by the decline in revenues. A
significant portion of operating income in 2000 resulted from favorable
adjustments for doubtful accounts based on collections from past due customers.
In addition, effective January 1, 2000, revenues for rehabilitation services
provided to Company-operated nursing centers approximated the costs of
providing such services. Accordingly, fiscal 2000 operating results do not
reflect any operating income related to intercompany transactions. Operating
results in 1999 also were negatively impacted as a result of a $26 million
increase in the provision for doubtful accounts. Operating results in 1998
include a $12 million charge related to third-party reimbursements. While the
health services division will continue to provide rehabilitation services to
nursing center customers, revenues and operating income related to these
services may continue to decline in 2001.
Health Services Division--Other Ancillary Services
Other ancillary services refers to certain ancillary businesses (primarily
respiratory therapy) that were discontinued as part of the Vencare realignment
in the fourth quarter of 1999. Operating results for 2000 reflect a $4 million
favorable adjustment for doubtful accounts resulting from collections from
discontinued customer accounts. See Note 4 of the Notes to Consolidated
Financial Statements for a description of the Vencare realignment.
Hospital Division--Hospitals
Revenues increased 19% in 2000 to $1.0 billion and declined 8% in 1999 to
$851 million. Revenues for both 2000 and 1999 were adversely impacted by
certain third-party reimbursement issues.
Prior to September 1999, Medicare revenues recorded by the Company's
hospitals included reimbursement for expenses related to certain costs
associated with hospital-based ancillary services provided by the former
Vencare division to its nursing center customers. As part of its ongoing
investigations, the DOJ objected to including such costs on the Medicare cost
reports filed by the Company's hospitals. Medicare revenues related to the
reimbursement of such costs aggregated $18 million in 1999 and $47 million in
1998. In connection with the negotiation of the Government Settlement, the
Company agreed to discontinue recording such revenues beginning September 1,
1999.
56
The Company provides care to patients covered by Medicare supplement
insurance policies which generally become effective when a patient's Medicare
benefits are exhausted. Disputes related to the level of payments to the
Company's hospitals have arisen with private insurance companies issuing these
policies as a result of different interpretations of policy provisions and
federal and state laws governing the policies. While the Company continues to
pursue favorable resolutions of these claims, provisions for loss aggregating
$20 million and $19 million were recorded in 2000 and 1999, respectively. See
"Legal Proceedings."
Revenues in 1999 were also reduced by adjustments for changes in estimates
for certain third-party reimbursements aggregating $60 million.
Excluding the effect of the previously discussed third-party reimbursement
issues, revenues grew 13% to $1.03 billion in 2000 and 4% to $912 million in
1999 compared to $873 million in 1998. The increase was primarily attributable
to patient day growth of 6% in 2000 and 4% in 1999. In addition, price
increases to private payors also contributed to revenue growth in 2000. Price
increases in 1999 were not significant.
Hospital operating income in 2000 totaled $206 million compared to $132
million in 1999 and $247 million in 1998. Excluding the previously discussed
third-party reimbursement issues, operating income totaled $226 million in
2000, $192 million in 1999 and $201 million in 1998. Growth in adjusted
operating income in 2000 was primarily attributable to revenue growth. Adjusted
operating income declined in 1999 compared to 1998 as a result of growth in
labor costs.
Hospital Division--Pharmacy
Revenues increased 19% in 2000 to $204 million and 14% in 1999 to $171
million. The increase in both periods resulted primarily from growth in the
number of nursing center customers and, in 1999, from price increases to
Company-operated nursing centers.
The Company's pharmacies reported operating income of $7 million in 2000
compared to $342,000 in 1999 and $15 million in 1998. Operating income in 1999
was reduced by a $11 million increase in the provision for doubtful accounts
compared to the prior year. Operating results in 1998 include the effect of
approximately $8 million of charges recorded in the fourth quarter related to
accounts receivable. Management believes that operating income in both 2000 and
1999 was adversely impacted by pricing pressures associated with PPS for
external customers.
Corporate Overhead
Operating income for the Company's operating divisions excludes allocations
of corporate overhead. These costs aggregated $114 million, $109 million and
$126 million during each of the last three years, respectively. As a percentage
of revenues (before eliminations), corporate overhead totaled 3.9% in 2000,
4.0% in 1999 and 4.1% in 1998.
Unusual Transactions
Operating results for each of the last three years include certain unusual
transactions. These transactions are included in other operating expenses in
the consolidated statement of operations (unless otherwise indicated) for the
respective periods in which they were recorded. See Note 6 of the Notes to
Consolidated Financial Statements.
2000
Operating results for 2000 include a $9.2 million write-off of an impaired
investment recorded in the third quarter and a $4.5 million gain on the sale of
a closed hospital recorded in the second quarter.
57
1999
The following table summarizes the pretax impact of unusual transactions
recorded during 1999 (in millions):
Quarters
-------------------------
First Second Third Fourth Year
----- ------ ----- ------ ------
(Income)/expense
Asset valuation losses:
Long-lived asset impairment........... $330.4 $330.4
Investment in BHC..................... $15.2 15.2
Cancellation of software development
project................................ 5.6 5.6
Realignment of Vencare division......... 56.3 56.3
Retirement plan curtailment............. 7.3 7.3
Corporate properties.................... (2.4) (2.4)
--- ----- --- ------ ------
$ - $20.8 $ - $391.6 $412.4
=== ===== === ====== ======
Long-lived asset impairment--Statement of Financial Accounting Standards
("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," ("SFAS 121"), requires impairment losses
to be recognized for long-lived assets used in operations when indications of
impairment are present and the estimate of undiscounted future cash flows is
not sufficient to recover asset carrying amounts. SFAS 121 also requires that
long-lived assets held for disposal be carried at the lower of carrying value
or fair value less costs of disposal, once management has committed to a plan
of disposal.
Operating results and related cash flows for 1999 did not meet management's
expectations. These expectations were the basis upon which the Company valued
its long-lived assets at December 31, 1998, in accordance with SFAS 121. In
addition, certain events occurred in 1999 which had a negative impact on the
Company's operating results and are expected to impact negatively its
operations in the future. In connection with the negotiation of the Government
Settlement, the Company agreed to exclude certain expenses from its hospital
Medicare cost reports beginning September 1, 1999 for which the Company had
been reimbursed in prior years. Medicare revenues related to the reimbursement
of such costs aggregated $18 million in 1999 and $47 million in 1998. In
addition, hospital revenues in 1999 were reduced by approximately $19 million
as a result of disputes with certain insurers who issued Medicare supplement
insurance policies to individuals who became patients of the Company's
hospitals. The Company also reviewed the expected impact of the BBRA enacted in
November 1999 (which provided a measure of relief for some of the impact of the
Budget Act) and the realignment of the Vencare ancillary services business
completed in the fourth quarter of 1999. The actual and expected future impact
of these issues served as an indication to management that the carrying values
of the Company's long-lived assets may be impaired.
In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and compared these estimates to the
carrying values of the underlying assets. As a result of these estimates, the
Company reduced the carrying amounts of the assets associated with 71 nursing
centers and 21 hospitals to their respective estimated fair values. The
determination of the fair values of the impaired facilities was based upon the
net present value of estimated future cash flows.
A summary of the impairment charges follows (in millions):
Property and
Goodwill Equipment Total
-------- ------------ ------
Health services division....................... $ 18.3 $ 37.7 $ 56.0
Hospital division.............................. 198.9 75.5 274.4
------ ------ ------
$217.2 $113.2 $330.4
====== ====== ======
58
Investment in BHC--In connection with the Transitional merger, the Company
acquired a 44% voting equity interest (61% equity interest) in Behavioral
Healthcare Corporation ("BHC"), an operator of psychiatric and behavioral
clinics. In the second quarter of 1999, the Company wrote off its remaining
investment in BHC aggregating $15.2 million as a result of deteriorating
financial performance. See the discussion of unusual transactions recorded in
1998 for further information related to the Company's investment in BHC.
Cancellation of software development project--In the second quarter of 1999,
the Company canceled a nursing center software development project and charged
previously capitalized costs to operations.
Realignment of Vencare division--As discussed in Note 4 of the Notes to
Consolidated Financial Statements, the Company realigned the Vencare ancillary
services division in the fourth quarter of 1999. As a result, the Company
recorded a charge aggregating $56.3 million, including the write-off of
goodwill totaling $42.3 million. The remainder of the charge related to the
write-down of certain equipment to net realizable value and the recording of
employee severance costs.
Retirement plan curtailment--In December 1999, the Board of Directors
approved the curtailment of benefits under the Company's supplemental executive
retirement plan, resulting in an actuarially determined charge of $7.3 million.
Under the terms of the curtailment, plan benefits were vested for each eligible
participant through December 31, 1999 and the accrual of future benefits under
the plan was substantially eliminated. The Board of Directors also deferred the
time at which certain benefits would be paid by the Company. See "Executive
Compensation--Supplemental Executive Retirement Plan."
Corporate properties--During 1999, the Company adjusted estimated property
loss provisions recorded in the fourth quarter of 1998, resulting in a pretax
credit of $2.4 million.
1998
The following table summarizes the pretax impact of unusual transactions
recorded during 1998 (in millions):
Quarters
---------------------------
First Second Third Fourth Year
----- ------ ------ ------ -------
(Income)/expense
Asset valuation losses:
Long-lived asset impairment........ $307.8 $ 307.8
Investment in BHC.................. $ 8.5 43.1 51.6
Wisconsin nursing center........... 27.5 27.5
Corporate properties............... $ 8.8 2.9 15.1 26.8
Acquired entities.................. 13.5 13.5
Gain on sale of investments.......... (98.5) (13.0) (111.5)
Losses from termination of
construction projects............... 71.3 71.3
Spin-off transaction costs........... $7.7 9.6 17.3
Write-off of clinical information
systems............................. 10.1 10.1
Doubtful accounts related to sold
operations.......................... 9.6 9.6
Settlement of litigation............. 7.8 7.8
Loss on sale and closure of home
health and hospice businesses....... 7.3 7.3
---- ----- ------ ------ -------
$7.7 $25.7 $ (6.2) $411.9 $ 439.1
==== ===== ====== ====== =======
Long-lived asset impairment--As previously discussed, all of the Company's
nursing centers became subject to PPS effective July 1, 1998. Revenues recorded
under PPS in the Company's health services division were substantially less
than the cost-based reimbursement it received before the enactment of the
Budget Act.
59
The Budget Act also reduced payments to the Company's hospitals by reducing
incentive payments pursuant to TEFRA, allowable costs for capital expenditures
and bad debts, and payments for services to patients transferred from a general
acute care hospital. These reductions, most of which became effective in 1998,
had a material adverse impact on hospital revenues.
The Company provides ancillary services to both Company-operated and non-
affiliated nursing centers. While most of the nursing center industry became
subject to PPS on or after January 1, 1999, management believed that Vencare's
ability to maintain services and revenues was impacted adversely during 1998,
particularly in the third and fourth quarters, since nursing centers were
reluctant to enter into ancillary service contracts while transitioning to the
new fixed payment system under PPS. Medicare reimbursements to nursing centers
under PPS include substantially all services provided to patients, including
ancillary services. Management believes that the decline in demand for its
Vencare services in 1998, particularly respiratory therapy and rehabilitation
therapy, was mostly attributable to efforts by nursing center customers to
reduce operating costs. In addition, as a result of these regulatory changes,
many nursing centers began providing ancillary services to their patients
through internal staff and no longer contracted with outside parties for
ancillary services.
In January 1998, HCFA issued rules changing Medicare reimbursement guidelines
for therapy services provided by the Company. Under these rules, HCFA
established salary equivalency limits for speech and occupational therapy
services and revised limits for physical and respiratory therapy services. The
new limits became effective for services provided on or after April 10, 1998
and negatively impacted operating results of the Company's ancillary services
businesses in 1998.
These significant regulatory changes and the impact of such changes on the
Company's operating results in the third and fourth quarters of 1998 served as
an indication to management that the carrying values of the assets of its
nursing center and hospital facilities, as well as certain portions of its
ancillary services business, may be impaired.
In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and ancillary services lines of business
and compared these estimates to the carrying values of the underlying assets.
As a result of these estimates, the Company reduced the carrying amounts of the
assets associated with 110 nursing centers, 12 hospitals and a portion of the
goodwill associated with its rehabilitation therapy business to their
respective estimated fair values. The determination of the fair values of the
impaired facilities and rehabilitation therapy business was based upon the net
present value of estimated future cash flows.
A summary of the impairment charges follows (in millions):
Property and
Goodwill Equipment Total
-------- ------------ ------
Health services division:
Nursing centers.............................. $ 27.7 $ 71.6 $ 99.3
Ancillary services........................... 99.2 0.2 99.4
Hospital division.............................. 74.4 34.7 109.1
------ ------ ------
$201.3 $106.5 $307.8
====== ====== ======
In addition to the above impairment charges, the amortization period for the
remaining goodwill associated with the Company's rehabilitation therapy
business was reduced from forty years to seven years, effective October 1,
1998. Management believed that the provisions of the Budget Act altered the
expected long-term cash flows and business prospects associated with this
business to such an extent that a shorter amortization period was deemed
appropriate. The change in the amortization period resulted in an additional
pretax charge to operations of $6.4 million in the fourth quarter of 1998. In
the fourth quarter of 1999, in connection with the realignment of Vencare, the
Company wrote off all of the goodwill associated with the rehabilitation
therapy business. See Note 6 of the Notes to Consolidated Financial Statements.
60
Investment in BHC--Subsequent to the Transitional merger, the Company had
been unsuccessful in its attempts to sell its investment in BHC. In July 1998,
the Company entered into an agreement to sell its interest in BHC for an amount
less than its carrying value and accordingly, a provision for loss of $8.5
million was recorded during the third quarter. In November 1998, the agreement
to sell the Company's interest in BHC was terminated by the prospective buyer,
indicating to the Company that the carrying amount of its investment may be
impaired. Following an independent appraisal, the Company recorded a $43.1
million write-down of the investment in the fourth quarter of 1998. The net
carrying amount of the investment aggregated $20.0 million at December 31,
1998.
Wisconsin nursing center--The Company recorded an asset impairment charge of
$27.5 million in the fourth quarter of 1998 related to a nursing center in
Wisconsin that is leased from Ventas. The impairment resulted primarily from
certain fourth quarter regulatory actions by state and federal agencies with
respect to the operation of the facility. In the fourth quarter of 1998, the
facility reported a pretax loss of $4.2 million and is not expected to generate
positive cash flows in the future.
Corporate properties and acquired entities--During 1998, the Company recorded
$26.8 million of charges related to the valuation of certain corporate assets,
the most significant of which relates to previously capitalized amounts and
expected property disposal losses associated with the cancellation of a
corporate headquarters construction project. The Company also recorded $13.5
million of asset write-downs associated with the Hillhaven merger, the TheraTx
merger and the Transitional merger, including provisions for obsolete or
abandoned computer equipment and miscellaneous receivables.
Gain on sale of investments--In September 1998, the Company sold its
investment in its assisted living affiliate, Atria Communities, Inc. for $177.5
million in cash and an equity interest in the surviving corporation, resulting
in a gain of $98.5 million. In November 1998, the Company's investment in
Colorado MEDtech, Inc. was sold at a gain of $13.0 million. Proceeds from the
sale were $22.0 million.
Losses from termination of construction projects--In the third quarter of
1998, as a result of substantial reductions in Medicare reimbursement to the
Company's nursing centers and hospitals in connection with the Budget Act,
management determined to suspend all acquisition and development activities,
terminate the construction of substantially all of its development properties,
and close two recently acquired hospitals. Accordingly, the Company recorded
pretax charges aggregating $71.3 million, of which $53.9 million related to the
cancellation of construction projects and the remainder related to the planned
closure of the hospitals. In connection with the construction termination
charge, the Company decided that it would not replace certain facilities that
previously were accounted for as assets intended for disposal. Accordingly, the
$53.9 million charge discussed above included a $10.0 million reversal of a
previously recorded valuation allowance (the amount necessary to reduce the
carrying value to fair value less costs of disposal) related to such
facilities.
Spin-off transaction costs--The Spin-off was completed on May 1, 1998. Direct
costs related to the transaction totaled $17.3 million and primarily included
costs for professional services.
Write-off of clinical information systems--During 1997, the Company began the
installation of its proprietary clinical information system, VenTouch(TM), in
several of its nursing centers. During the pilot process, the Company
determined that VenTouch(TM) did not support effectively the nursing center
processes, especially in facilities with lower acuity patients. Accordingly,
management determined in the fourth quarter of 1998 to remove VenTouch(TM) from
these facilities during 1999. A loss of $10.1 million was recorded to reflect
the write-off of the equipment and estimated costs of removal from the
facilities.
Doubtful accounts related to sold operations--In the third quarter of 1998,
the Company recorded $9.6 million of additional provisions for doubtful
accounts for accounts receivable associated with previously sold facilities.
Settlement of litigation--The Company settled a legal action entitled
Highland Pines Nursing Center, Inc., et al. v. TheraTx, Incorporated, et al.
(assumed in connection with the TheraTx merger) which resulted in a
61
payment of $16.2 million. Approximately $7.8 million of the settlement was
charged to earnings in the fourth quarter of 1998, and the remainder of such
costs had been previously accrued in connection with the purchase price
allocation.
Loss on sale and closure of home health and hospice businesses--The Company
began operating its home health and hospice businesses in 1996. These
operations generally were unprofitable. In the second quarter of 1998,
management decided to cease operations and either close or sell these
businesses, resulting in a loss of $7.3 million.
Capital Costs
Upon completion of the Spin-off, the Company leased substantially all of its
facilities. Prior thereto, the Company owned 271 facilities and leased 80
facilities from third parties. Depreciation and amortization, rent and net
interest costs aggregated $436 million in 2000, $474 million in 1999 and $461
million in 1998. Rent expense incurred by the Company in connection with the
Master Lease Agreements aggregated $230 million in 2000, $225 million in 1999
and $148 million in 1998. In connection with the Spin-off in 1998,
approximately $992 million of long-term debt was retained by Ventas.
During the pendency of the Chapter 11 Cases, the Company is continuing to
record the entire contractual amount of interest expense related to the Credit
Agreement and the rents due to Ventas under the Master Lease Agreements. No
interest payments have been made related to the Credit Agreement since the
filing of the Chapter 11 Cases. In accordance with the Stipulation with
Ventas, the Company is paying a reduced aggregate monthly rent of
approximately $15.1 million.
No interest costs have been recorded related to the 1998 Notes since the
filing of the Chapter 11 Cases. Contractual interest expense for the 1998
Notes not recorded in the consolidated statement of operations aggregated $30
million in 2000 and $9 million in 1999.
Fourth Quarter Adjustments
Preparation of the financial statements requires a number of estimates and
judgments that are based upon the best available evidence at the time. In
addition, management regularly reviews the methods used to recognize revenues
and allocate costs to ensure that the financial statements reflect properly
the results of interim periods.
In addition to the unusual transactions previously discussed, during the
fourth quarter of 1999 and 1998, the Company recorded certain adjustments
which significantly impacted operating results. A summary of such adjustments
follows (in millions):
(Restated)
-----------------------------------------------------
Health Services
Division Hospital Division
----------------- ------------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- ------
1999
(Income)/expense
Provision for doubtful
accounts............. $40.2 $26.8 $ 6.5 $ 8.9 $ 82.4
Medicare supplement
insurance disputes... 18.8 18.8
Third-party
reimbursements and
contractual
allowances, including
amounts due from
government agencies
and other payors that
are subject to
dispute.............. 2.0 59.6 61.6
Professional liability
risks................ 14.7 0.4 1.8 0.1 17.0
Employee benefits..... (6.3) (1.5) (1.8) (9.6)
Incentive
compensation......... 2.2 (1.9) (1.1) (0.8)
Inventories........... 0.9 6.3 7.2
Other................. 1.7 (0.4) 2.0 (4.4) $(2.8) (3.9)
----- ----- ----- ----- ----- ------
$55.4 $25.3 $85.0 $ 9.8 $(2.8) $172.7
===== ===== ===== ===== ===== ======
62
(Restated)
----------------------------------------------------
Health Services
Division Hospital Division
----------------- ------------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- -----
1998
(Income)/expense
Provision for doubtful
accounts.............. $14.0 $ 6.8 $ 5.7 $ 2.5 $29.0
Third-party
reimbursements and
contractual
allowances, including
amounts due from
government agencies
and other payors that
are subject to
dispute............... 4.8 11.5 11.4 27.7
Change in goodwill
amortization period
related to
rehabilitation therapy
business.............. 6.4 6.4
Taxes other than
income................ $ 6.4 6.4
Professional liability
risks................. 3.5 0.2 1.8 5.5
Compensated absences... 2.1 1.3 (0.8) 0.7 3.3
Incentive
compensation.......... (1.0) (0.4) (0.8) (0.1) (2.9) (5.2)
Litigation and
regulatory actions.... 3.5 3.5
Miscellaneous
receivables........... 5.2 5.2
Gain on sale of
assets................ (2.0) (2.0)
Other.................. 1.2 0.4 (1.0) 0.3 3.7 4.6
----- ----- ----- ----- ----- -----
$24.6 $24.2 $16.3 $ 7.9 $11.4 $84.4
===== ===== ===== ===== ===== =====
The Company regularly reviews its accounts receivable and records provisions
for loss based upon the best available evidence. Factors such as changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors (including both government
and non-government sources), the effect of increased regulatory activities,
general industry conditions and the financial condition of the Company and its
ancillary service customers, among other things, are considered by management
in determining the expected collectibility of accounts receivable.
During 1999 and 1998, the Company recorded significant adjustments in the
fourth quarter related to contractual allowances and doubtful accounts in each
of its divisions. These adjustments represented changes in estimates resulting
from management's assessment of its collection processes, the general financial
deterioration of the long-term healthcare industry and, in 1999, the
realignment of the Vencare businesses (including the cancellation of
unprofitable contracts and the discontinuance of certain services) and the
filing of the Chapter 11 Cases in September 1999.
In addition, the Company recorded a significant adjustment in the fourth
quarter of 1999 related to professional liability risks. This adjustment was
recorded based upon actuarially determined estimates completed in the fourth
quarter and reflects substantial increases in claims and litigation activity in
the Company's nursing center business during 1999. Management believes that
cost increases for professional liability risks are negatively impacting other
providers in the long-term healthcare industry and expects that the Company's
operating results in the future may be impacted negatively by additional
professional liability costs. See Note 10 of the Notes to Consolidated
Financial Statements.
Income Taxes
Prior to 1998, management believed that recorded deferred tax assets
ultimately would be realized. Management's conclusions at that time were based
primarily on the existence of sufficient taxable income within the allowable
carryback periods to realize the tax benefits of deductible temporary
differences recorded at December 31, 1997. For the fourth quarter of 1998, the
Company reported a pretax loss of $512 million. Additionally, the Company
revised its operating budgets as a result of the Budget Act and the less than
expected operating results in 1998. Based upon those revised forecasts,
management did not believe that the
63
Company could generate sufficient taxable income to realize the net deferred
tax assets recorded at December 31, 1998. Accordingly, the Company recorded a
deferred tax valuation allowance aggregating $205 million in the fourth quarter
of 1998. Deferred tax valuation allowances recorded in 1999 and 2000 totaled
$155 million and $12 million, respectively. The deferred tax valuation
allowance included in the consolidated balance sheet at December 31, 2000
totaled $372 million. See Note 9 of the Notes to Consolidated Financial
Statements.
Consolidated Results
The Company reported a pretax loss from operations before reorganization
costs of $50 million in 2000 compared to $686 million in 1999 and $502 million
in 1998. Reorganization costs in 2000 and 1999 aggregating $13 million and $19
million, respectively, principally comprised professional fees and, in 1999,
certain management incentive payments incurred in connection with the Company's
restructuring activities.
The net loss from operations in 2000 totaled $65 million compared to $705
million in 1999 and $578 million in 1998 (including charges to record the
deferred tax valuation allowance).
Effective January 1, 1999, the Company adopted the provisions of the American
Institute of Certified Public Accountants Statement of Position ("SOP") 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), which requires
the Company to expense start-up costs, including organizational costs, as
incurred. In accordance with the provision of SOP 98-5, the Company wrote off
$8.9 million of such unamortized costs as a cumulative effect of a change in
accounting principle in the first quarter of 1999. The pro forma effect of the
change in accounting for start-up costs, assuming the change occurred on
January 1, 1998, was not significant.
In conjunction with the Spin-off in 1998, the Company incurred an
extraordinary loss on extinguishment of debt aggregating $78 million.
Liquidity
As previously discussed, on September 13, 1999, the Company and substantially
all of its subsidiaries filed voluntary petitions for protection under Chapter
11 of the Bankruptcy Code. The Company currently is operating its businesses as
a debtor-in-possession subject to the jurisdiction of the Bankruptcy Court. See
"Business--Proceedings under Chapter 11 of the Bankruptcy Code."
On September 14, 1999, the Company received approval from the Bankruptcy
Court to pay pre-petition and post-petition employee wages, salaries, benefits
and other employee obligations. The Bankruptcy Court also approved orders
granting authority, among other things, to pay pre-petition claims of certain
critical vendors, utilities and patient obligations. All other pre-petition
liabilities have been classified in the Company's consolidated balance sheet as
liabilities subject to compromise. The Company currently is paying the post-
petition claims of all vendors and providers in the ordinary course of
business.
In connection with the Chapter 11 Cases, the Company entered into the DIP
Financing aggregating $100 million. The Bankruptcy Court granted final approval
of the DIP Financing on October 1, 1999. The DIP Financing was initially
comprised of a $75 million Tranche A Loan and a $25 million Tranche B Loan.
Interest is payable at prime plus 2 1/2% on the Tranche A Loan and prime plus 4
1/2% on the Tranche B Loan.
Available aggregate borrowings under the Tranche A Loan were initially
limited to $45 million in September 1999 and increased to $65 million in
October 1999, $70 million in November 1999 and $75 million thereafter. Pursuant
to the most recent amendment to the DIP Financing, the aggregate borrowing
limitations under the Tranche A Loan are limited to approximately $48 million
until maturity and are reduced for asset sales made by the Company. In
addition, Tranche B Loan aggregate borrowings are limited to $23 million as a
result of the most recent amendment to the DIP Financing. Borrowings under the
Tranche B Loan require the approval of lenders holding at least 75% of the
credit exposure under the DIP Financing. The DIP Financing is
64
secured by substantially all of the assets of the Company and its subsidiaries,
including certain owned real property. The DIP Financing contains standard
representations and warranties and other affirmative and restrictive covenants.
At December 31, 2000, there were no outstanding borrowings under the DIP
Financing.
Since the consummation of the DIP Financing, the Company and the DIP Lenders
have agreed to several amendments to the DIP Financing. In the most recent
amendment to the DIP Financing, the parties agreed, among other things, to
extend the maturity date of the DIP Financing until March 31, 2001 and to
revise and update certain financial covenants. At December 31, 2000, the
Company was in compliance with the terms of the DIP Financing.
The Company expects to terminate the DIP Financing on or prior to the
effective date of the Amended Plan.
The Company reported a net loss from operations in 1998 aggregating $578
million, resulting in certain financial covenant violations under the Company's
$1.0 billion Credit Agreement. Prior to the commencement of the Chapter 11
Cases, the Company received a series of temporary waivers of these covenant
violations. The waivers generally included certain borrowing limitations under
the $300 million revolving credit portion of the Credit Agreement. The final
waiver was scheduled to expire on September 24, 1999.
The Company was informed on April 9, 1999 by HCFA that the Medicare program
had made a demand for repayment of approximately $90 million of reimbursement
overpayments. On April 21, 1999, the Company reached an agreement with HCFA to
extend the repayment of such amounts over 60 monthly installments. Under the
HCFA Agreement, non-interest bearing monthly payments of approximately $1.5
million commenced in May 1999. Beginning in December 1999, interest began to
accrue on the balance of the overpayments at a statutory rate approximating
13.4%, resulting in a monthly payment of approximately $2.0 million through
March 2004. If the Company is delinquent with two consecutive payments, the
HCFA Agreement will be defaulted and all subsequent Medicare reimbursement
payments to the Company may be withheld. Amounts due under the HCFA Agreement
aggregated $63.4 million at December 31, 2000 and have been classified as
liabilities subject to compromise in the Company's consolidated balance sheet.
The Company has received Bankruptcy Court approval to continue to make the
monthly payments under the HCFA Agreement during the pendency of the Chapter 11
Cases. Under the Amended Plan, if consummated, the Company has agreed to repay
the remaining balance of the obligations pursuant to the terms of the HCFA
Agreement.
On May 3, 1999, the Company elected not to make the interest payment of
approximately $14.8 million due on the 1998 Notes. The failure to pay interest
resulted in an event of default under the 1998 Notes.
In accordance with SOP 90-7 "Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code" ("SOP 90-7"), outstanding borrowings
under the Credit Agreement ($511 million) and the principal amount of the 1998
Notes ($300 million) have been presented as liabilities subject to compromise
in the Company's consolidated balance sheet at December 31, 2000. If the
Chapter 11 Cases had not been filed, the Company would have reported a working
capital deficit approximating $942 million at December 31, 2000. The
consolidated financial statements do not include any adjustments that might
result from the resolution of the Chapter 11 Cases or other matters discussed
herein. During the pendency of the Chapter 11 Cases, the Company is continuing
to record the contractual amount of interest expense related to the Credit
Agreement. No interest costs have been recorded related to the 1998 Notes since
the filing of the Chapter 11 Cases. Contractual interest expense for the 1998
Notes not recorded in the consolidated statement of operations aggregated $30
million in 2000 and $9 million in 1999.
As previously reported, the Company was informed by the DOJ that the Company
and Ventas are the subjects of ongoing investigations into various Medicare
reimbursement issues, including hospital cost reporting issues, Vencare billing
practices and various quality of care issues in the hospitals and nursing
centers
65
formerly operated by Ventas and currently operated by the Company. In
connection with the Amended Plan, the claims of the DOJ will be settled through
the Government Settlement. The Government Settlement also provides for the
dismissal of certain pending claims and lawsuits filed against the Company. See
"Business--Proceedings under Chapter 11 of the Bankruptcy Code" and "Legal
Proceedings."
As a result of the uncertainty related to the Chapter 11 Cases, the original
report of the Company's independent accountants, PricewaterhouseCoopers LLP,
referred to the Company's ability to continue as a going concern at December
31, 2000 and December 31, 1999. As a result of the Company's net loss in 1998,
its working capital deficiency and its covenant defaults under the Credit
Agreement at December 31, 1998, the report of the Company's former independent
accountants, Ernst & Young LLP, refers to the Company's ability to continue as
a going concern at December 31, 1998.
Cash provided by operations before reorganization costs totaled $194 million
for 2000 compared to $247 million for 1999 and $323 million for 1998. Cash
flows in 1999 and 1998 were unusually high due to growth in amounts due to
third parties. Overpayments from third-party payors resulted from the Medicare
program continuing to reimburse the Company's nursing centers under the prior
cost-based reimbursement system after the Company's nursing centers had
converted to PPS.
In January 2000, the Company filed its hospital cost reports for the year
ended August 31, 1999. These documents are filed annually in settlement of
amounts due to or from the various agencies administering the reimbursement
programs. These cost reports indicated amounts due from the Company aggregating
$58 million. This liability arose during 1999 as part of the Company's routine
settlement of Medicare reimbursement overpayments. Such amounts were classified
as liabilities subject to compromise in the consolidated balance sheet and,
accordingly, no funds were disbursed by the Company in settlement of such pre-
petition liabilities. Under the terms of the Amended Plan, the Company believes
that this obligation will be discharged.
On or prior to the effective date of the Amended Plan, the Company intends to
execute definitive agreements related to the Exit Facility in accordance with
the terms of a commitment letter. The Exit Facility will constitute a general
working capital facility for general corporate purposes, including any payments
under the HCFA Agreement and other pre-petition liabilities payable pursuant to
the Amended Plan. The Exit Facility is expected to consist of a five-year $120
million revolving credit facility and provide for $40 million of letter of
credit availability. Direct borrowings under the Exit Facility will bear
interest, at the option of the Company, at (a) prime (or, if higher, the
federal funds rate plus 1/2%) plus 3% or (b) one, two, three or six month LIBOR
plus 4%. The Exit Facility will be secured by substantially all of the assets
of the Company and its subsidiaries, including certain owned real property.
The consummation of the Exit Facility is subject to various conditions,
including but not limited to, the negotiation of definitive documentation and
consummation of the Amended Plan. There can be no assurance that such
conditions will be satisfied or that the Exit Facility will be executed.
Capital Resources
Excluding acquisitions, capital expenditures totaled $80 million for 2000
compared to $111 million for 1999 and $267 million for 1998. Planned capital
expenditures in 2001 (excluding acquisitions) are expected to approximate $75
million. Management believes that its capital expenditure program is adequate
to expand, improve and equip existing facilities.
Capital expenditures during the last three years were financed primarily
through internally generated funds. At December 31, 2000, the estimated cost to
complete and equip construction in progress approximated $8 million.
Proceeds from the sale of assets totaled $15 million in 2000, $12 million in
1999 and $237 million in 1998. Substantially all of the proceeds in 1998 were
used to reduce long-term debt.
66
At December 31, 1999, the Company was a party to certain interest rate swap
agreements that eliminated the impact of changes in interest rates on $100
million of floating rate debt outstanding. The agreements provided for fixed
rates on $100 million of floating rate debt at 6.4% plus 3/8% to 1 1/8% and
expired in May 2000. The Company was not a party to any interest rate swap
agreements at December 31, 2000.
Other Information
Effects of Inflation and Changing Prices
The Company derives a substantial portion of its revenues from the Medicare
and Medicaid programs. In recent years, significant cost containment measures
enacted by Congress and certain state legislators have limited the Company's
ability to recover its cost increases through increased pricing of its
healthcare services. Medicare revenues in the Company's nursing centers are
subject to fixed payments under PPS. Medicaid reimbursement rates in many
states in which the Company operates nursing centers also are based on fixed
payment systems. In addition, by repealing the Boren Amendment, the Budget Act
eases existing impediments on the states' ability to reduce Medicaid
reimbursement levels to the Company's nursing centers. Medicare revenues in the
Company's hospitals also have been reduced by the Budget Act.
During 2000, the BBRA provided a measure of relief to the Medicare
reimbursement reductions imposed by the Budget Act. The enactment of BIPA in
December 2000 will provide additional Medicare reimbursement beginning in April
2001. Management believes that these legislative actions will have a positive
impact on the Company's revenues in 2001, particularly in the health services
division.
Management believes, however, that its operating margins may continue to be
under pressure because of continuing regulatory scrutiny and growth in
operating expenses in excess of anticipated increases in payments by 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.
Litigation
The Company is a party to certain material litigation and regulatory actions
as well as various lawsuits and claims arising in the ordinary course of
business. See "Legal Proceedings."
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company's only significant exposure to market risk is changes in the
levels of various interest rates. In this regard, changes in LIBOR interest
rates affect the interest paid on its borrowings. In addition, the interest
rates on borrowings under the DIP Financing are affected by changes in the
federal funds rate and the prime rate of Morgan Guaranty Trust Company of New
York. To mitigate the impact of fluctuations in these interest rates, the
Company generally maintained a portion of its borrowings on a fixed rate, long-
term basis. Prior to its financial difficulties, the Company also entered into
interest rate swap transactions. The Company was not a party to any interest
rate swap agreements at December 31, 2000.
As previously discussed, the Company filed the Chapter 11 Cases on September
13, 1999. Accordingly, all amounts disclosed in the table below are subject to
compromise in connection with the Chapter 11 Cases. While the fair values of
the Company's debt obligations have declined significantly as a result of the
Chapter 11 Cases, such amounts do not reflect any adjustments that might result
from resolutions of the Chapter 11 Cases or other matters discussed herein.
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
against the Company are subject to an automatic stay and other contractual
obligations against the Company may not be enforced. In addition, the Company
may assume or reject executory contracts under the Bankruptcy Code.
67
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. The table
constitutes a forward-looking statement. 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
2001 2002 2003 2004 2005 Thereafter Total 12/31/00
------- -------- ------- -------- -------- ---------- -------- --------
Liabilities:
Long-term debt,
including amounts due
within one year:
Fixed rate............. $17,958 $ 19,619 $21,503 $ 5,717 $300,047 $3,825 $368,669 $118,385
Average interest rate.. 11.9% 11.9% 10.5% 9.3% 8.9% 8.6%
Variable rate.......... $66,768 $128,640 $96,509 $177,344 $ 41,647 $ - $510,908 $418,945
Average interest rate
(a)
--------
(a) Interest is payable, depending on the debt instrument, certain leverage
ratios and other factors, at a rate of LIBOR plus 3/4% to 3 1/2% or prime
plus 2% to 3 1/2%.
Item 8. Financial Statements and Supplementary Data
The information required by this Item 8 is included in appendix pages F-2
through F-49 of this Annual Report on Form 10-K/A.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
The Company, upon approval of its Board of Directors, appointed
PricewaterhouseCoopers LLP ("PwC") as its independent auditors for the fiscal
year ending December 31, 1999 to replace Ernst & Young LLP ("Ernst & Young")
effective November 2, 1999. The Board of Directors was advised by counsel that
the participation of Ernst & Young in the Company's Spin-off presented a
potential conflict of interest that would significantly jeopardize the ability
of Ernst & Young to be approved as independent auditors for the Company by the
Bankruptcy Court. The audit report of Ernst & Young on the consolidated
financial statements of the Company and its subsidiaries as of and for the year
ended December 31, 1998, did not contain any adverse opinion or disclaimer of
opinion, nor was it qualified or modified as to audit scope or accounting
principles. The opinion of Ernst & Young for the year ended December 31, 1998
was modified as to uncertainty by the inclusion of an explanatory "going
concern" paragraph resulting from the Company's net loss in 1998, working
capital deficiency and covenant defaults under its Credit Agreement.
In connection with the audit for the year ended December 31, 1998 and the
subsequent interim period through November 2, 1999, there were no disagreements
with Ernst & Young on any accounting principles or practices, financial
statement disclosures, or auditing scope or procedures, which if not resolved
to the satisfaction of Ernst & Young, would have caused it to make a reference
to the subject matter of the disagreement in their report.
In connection with the audit of the Company's consolidated financial
statements for the year ended December 31, 1998, Ernst & Young informed the
Company and the Audit and Compliance Committee of its Board of Directors of a
condition that it believed constituted a material weakness in the Company's
internal controls. Ernst & Young communicated that certain of the Company's
account reconciliations had not been completed on a timely basis. Additionally,
Ernst & Young stated that there was a lack of appropriate follow up and
resolution of reconciling items, including adjustments of the accounting
records on a timely basis, and there was a lack of evidence of review of the
reconciliations by an independent person. The Company did
68
reconcile all accounts and recorded the appropriate adjustments prior to the
filing of its Annual Report on Form 10-K for the year ended December 31, 1998.
Ernst & Young advised the Company that, in completing its audit, it considered
the aforementioned material weakness in determining the nature, timing and
extent of procedures performed to enable it to issue its opinion on the
consolidated financial statements. The Company has authorized Ernst & Young to
respond fully to the inquiries of PwC concerning these matters.
The Company requested that Ernst & Young furnish it with a letter addressed
to the Commission stating whether or not it agrees with the statements set
forth above. A copy of such letter dated November 5, 1999 was filed with the
Commission on a Current Report on Form 8-K filed by the Company.
69
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Index to Consolidated Financial Statements and Financial Statement
Schedules:
Page
----
Report of PricewaterhouseCoopers LLP...................................... F-2
Report of Ernst & Young LLP............................................... F-3
Consolidated Financial Statements (restated):
Consolidated Statement of Operations for the years ended December 31,
2000, 1999 and 1998.................................................... F-4
Consolidated Balance Sheet, December 31, 2000 and 1999.................. F-5
Consolidated Statement of Stockholders' Equity (Deficit) for the years
ended December 31, 2000, 1999 and 1998................................. F-6
Consolidated Statement of Cash Flows for the years ended December 31,
2000, 1999 and 1998.................................................... F-7
Notes to Consolidated Financial Statements.............................. F-8
Quarterly Consolidated Financial Information (Unaudited)................ F-48
Financial Statement Schedule (a):
Schedule II--Valuation and Qualifying Accounts for the years ended
December 31, 2000, 1999 and 1998....................................... F-49
--------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.
(a)(2) Index to Exhibits:
EXHIBIT INDEX
Exhibit
Number Description of Document
------- -----------------------
2.1 Fourth Amended Joint Plan of Reorganization of Vencor, Inc. and
Affiliated Debtors under Chapter 11 of the Bankruptcy Code. Exhibit
2.1 to the Current Report on Form 8-K of the Company dated March 19,
2001 (Comm. File No. 001-14057) is hereby incorporated by reference.
2.2 Order Confirming the Fourth Amended Joint Plan of Reorganization of
Vencor, Inc. and Affiliated Debtors under Chapter 11 of the Bankruptcy
Code, as entered by the United States Bankruptcy Court for the
District of Delaware on March 16, 2001. Exhibit 2.2 to the Current
Report on Form 8-K of the Company dated March 19, 2001 (Comm. File No.
001-14057) is hereby incorporated by reference.
3.1 Restated Certificate of Incorporation of the Company. Exhibit 3.1 to
the Company's Form 10, as amended, dated April 27, 1998 (Comm. File
No. 001-14057) is hereby incorporated by reference.
3.2 Amended and Restated Bylaws of the Company. Exhibit 3.2 to the
Company's Form 10, as amended, dated April 27, 1998 (Comm. File No.
001-14057) is hereby incorporated by reference.
4.1 Articles IV and X of the Restated Certificate of Incorporation of the
Company is included in Exhibit 3.1.
4.2 Indenture dated April 30, 1998, among Vencor, Inc., Vencor Operating,
Inc. and PNC Bank, National Association, as Trustee. Exhibit 4.1 to
the Company's Registration Statement on Form S-4 (Reg. No. 333-57953)
is hereby incorporated by reference.
4.3 Instrument of Resignation, Appointment and Acceptance, dated as of
September 16, 1999 among Vencor Operating, Inc., Vencor, Inc., The
Chase Manhattan Bank (successor to PNC Bank, National Association) and
HSBC Bank USA, as Successor Trustee. Exhibit 4.3 to the Company's Form
10-K for the year ended December 31, 1999 (Comm. File No. 001-14057)
is hereby incorporated by reference.
4.4 Form of 9 7/8% Guaranteed Senior Subordinated Notes due 2005 (included
in Exhibit 4.2).
70
Exhibit
Number Description of Document
------- -----------------------
4.5 Form of the Company's 8 5/8% Senior Subordinated Notes due 2007.
Exhibit 4.1 to the Ventas, Inc. Current Report on Form 8-K dated July
21, 1997 (Comm. File No. 1-10989) is hereby incorporated by reference.
4.6 Indenture dated as of July 21, 1997, between the Company and the Bank
of New York, as Trustee. Exhibit 4.2 to the Ventas, Inc. Current
Report of Form 8-K dated July 21, 1997 (Comm. File No. 1-10989) is
hereby incorporated by reference.
10.1 Credit Agreement dated as of April 29, 1998 among Vencor, Inc., Vencor
Operating, Inc., the Lenders party thereto, the Swingline Bank party
thereto, the LC Issuing Banks party thereto, the Senior Managing
Agents, Managing Agents and Co-Agents party thereto, Morgan Guaranty
Trust Company of New York and NationsBank, N.A. Exhibit 10.1 to the
Company's Registration Statement on Form S-4 (Reg. No. 333-57953) is
hereby incorporated by reference.
10.2 Amendment No. 1 dated as of September 30, 1998 to the Credit Agreement
dated as of April 29, 1998 among Vencor Operating, Inc., Vencor, Inc.,
the Lenders, Swingline Bank, LC Issuing Banks, Senior Managing Agents,
Managing Agents and Co-Agents party thereto, Morgan Guaranty Trust
Company of New York, as Documentation Agent and Collateral Agent, and
NationsBank, N.A., as Administrative Agent. Exhibit 10.2 to the
Company's Form 10-K for the year ended December 31, 1998 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.3 Waiver No. 2 to the Credit Agreement dated as of March 31, 1999 among
Vencor Operating, Inc., Vencor, Inc., the Lenders, Swingline Bank and
LC Issuing Banks party thereto, the Senior Managing Agents, Managing
Agents and Co-Agents party thereto and Morgan Guaranty Trust Company
of New York, as Documentation Agent and Collateral Agent, and
NationsBank, N.A., as Administrative Agent. Exhibit 99.2 to the
Current Report on Form 8-K of the Company dated March 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.4 Waiver No. 3 dated as of May 28, 1999, under the Credit Agreement
dated as of April 29, 1998 among Vencor Operating, Inc., Vencor, Inc.,
the Lenders, Swingline Bank and LC Issuing Banks party thereto, the
Senior Managing Agents, Managing Agents and Co-Agents party thereto
and Morgan Guaranty Trust Company of New York, as Documentation Agent
and Collateral Agent, and NationsBank, N.A., as Administrative Agent.
Exhibit 99.2 to the Current Report on Form 8-K of the Company dated
May 28, 1999 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.5 Waiver No. 4 dated as of July 30, 1999, under the Credit Agreement
dated as of April 29, 1998 among Vencor Operating, Inc., Vencor, Inc.,
the Lenders, Swingline Bank and LC Issuing Banks party thereto, the
Senior Managing Agents, Managing Agents and Co-Agents party thereto
and Morgan Guaranty Trust Company of New York, as Documentation Agent
and Collateral Agent, and NationsBank, N.A., as Administrative Agent.
Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended
June 30, 1999 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.6 Waiver No. 5 dated as of August 27, 1999, under the Credit Agreement
dated as of April 29, 1998 among Vencor Operating, Inc., Vencor, Inc.,
the Lenders, Swingline Bank and LC Issuing Banks party thereto, the
Senior Managing Agents, Managing Agents and Co-Agents party thereto
and Morgan Guaranty Trust Company of New York, as Documentation Agent
and Collateral Agent, and NationsBank, N.A., as Administrative Agent.
Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended
September 30, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.7 Debtor-in-Possession Credit Agreement dated as of September 13, 1999,
among Vencor, Inc., Vencor Operating, Inc. and each of the
subsidiaries of Vencor, Inc. party thereto, the Lenders party thereto,
the LC Issuing Banks party thereto and Morgan Guaranty Trust Company
of New York as Arranger, Collateral Agent and Administrative Agent.
Exhibit 10.3 to the Company's Form 10-Q for the quarterly period ended
September 30, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
71
Exhibit
Number Description of Document
------- -----------------------
10.8 First Amendment to Debtor-in-Possession Credit Agreement and First
Amendment to Security Agreement dated October 21, 1999 among Vencor,
Inc., Vencor Operating, Inc. and each of Vencor's subsidiaries listed
on the signature pages thereof, the Lenders listed on the signature
page thereof and Morgan Guaranty Trust Company of New York as
Arranger, Collateral Agent and Administrative
Agent. Exhibit 10.8 to the Company's Form 10-K for the year ended
December 31, 1999 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.9 Second Amendment to Debtor-in-Possession Credit Agreement dated
November 19, 1999 among Vencor, Inc., Vencor Operating, Inc. and each
of Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.9 to the Company's Form 10-K for the
year ended December 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.10 Third Amendment to Debtor-in-Possession Credit Agreement dated
December 23, 1999 among Vencor, Inc., Vencor Operating, Inc. and each
of Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.10 to the Company's Form 10-K for the
year ended December 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.11 Fourth Amendment to Debtor-in-Possession Credit Agreement dated
February 9, 2000 among Vencor, Inc., Vencor Operating, Inc. and each
of Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.11 to the Company's Form 10-K for the
year ended December 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.12 Fifth Amendment to Debtor-in-Possession Credit Agreement dated
February 23, 2000 among Vencor, Inc., Vencor Operating, Inc. and each
of Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.12 to the Company's Form 10-K for the
year ended December 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.13 Sixth Amendment to Debtor-in-Possession Credit Agreement dated April
7, 2000 among Vencor, Inc., Vencor Operating, Inc. and each of
Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.3 to the Company's Form 10-Q for the
quarterly period ended March 31, 2000 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.14 Seventh Amendment to Debtor-in-Possession Credit Agreement dated April
26, 2000 among Vencor, Inc., Vencor Operating, Inc. and each of
Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.4 to the Company's Form 10-Q for the
quarterly period ended March 31, 2000 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.15 Eighth Amendment to Debtor-in-Possession Credit Agreement dated June
8, 2000 among Vencor, Inc., Vencor Operating, Inc. and each of
Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.3 to the Company's Form 10-Q for the
quarterly period ended June 30, 2000 (Comm. File No. 001-14057) is
hereby incorporated by reference.
72
Exhibit
Number Description of Document
------- -----------------------
10.16 Amendment to Debtor-in-Possession Credit Agreement to Extend Plan
Filing Date dated July 11, 2000 among Vencor, Inc., Vencor Operating,
Inc. and each of Vencor's subsidiaries listed on the signature pages
thereof, the Lenders listed on the signature pages thereof and Morgan
Guaranty Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.5 to the
Company's Form 10-Q for the quarterly period ended June 30, 2000
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.17 Amendment to Debtor-in-Possession Credit Agreement dated August 16,
2000 among Vencor, Inc., Vencor Operating, Inc. and each of Vencor's
subsidiaries listed on the signature pages thereof, the Lenders listed
on the signature pages thereof and Morgan Guaranty Trust Company of
New York as Arranger, Collateral Agent and Administrative Agent.
Exhibit 10.2 to the Company's Form 10-Q for the quarterly period ended
September 30, 2000 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.18 Twelfth Amendment and Consent to Debtor-in-Possession Credit Agreement
dated September 22, 2000 among Vencor, Inc., Vencor Operating, Inc.
and each of Vencor's subsidiaries listed on the signature pages
thereof, the Lenders listed on the signature pages thereof and Morgan
Guaranty Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.3 to the Company's Form 10-Q for the
quarterly period ended September 30, 2000 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.19 Thirteenth Amendment and Consent to Debtor-in-Possession Credit
Agreement dated October 23, 2000 among Vencor, Inc., Vencor Operating,
Inc. and each of Vencor's subsidiaries listed on the signature pages
thereof, the Lenders listed on the signature pages thereof and Morgan
Guaranty Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent. Exhibit 10.4 to the Company's Form 10-Q for the
quarterly period ended September 30, 2000 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.20 Fourteenth Amendment to Debtor-in-Possession Credit Agreement dated
November 22, 2000 among Vencor, Inc., Vencor Operating, Inc. and each
of Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent.
10.21 Fifteenth Amendment to Debtor-in-Possession Credit Agreement dated
December 20, 2000 among Vencor, Inc., Vencor Operating, Inc. and each
of Vencor's subsidiaries listed on the signature pages thereof, the
Lenders listed on the signature pages thereof and Morgan Guaranty
Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent.
10.22 Sixteenth Amendment and Consent to Debtor-in-Possession Credit
Agreement dated January 19, 2001 among Vencor, Inc., Vencor Operating,
Inc. and each of Vencor's subsidiaries listed on the signature pages
thereof, the Lenders listed on the signature pages thereof and Morgan
Guaranty Trust Company of New York as Arranger, Collateral Agent and
Administrative Agent.
10.23 Master Trust Agreement dated January 17, 2000 by and between Vencor,
Inc. and Norwest Bank Minnesota, National Association. Exhibit 10.5 to
the Company's Form 10-Q for the quarterly period ended March 31, 2000
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.24 Vencor Retirement Savings Plan Amended and Restated effective as of
March 1, 2000. Exhibit 10.6 to the Company's Form 10-Q for the
quarterly period ended March 31, 2000 (Comm. File No. 001-14057) is
hereby incorporated by reference.
10.25 Retirement Savings Plan for Certain Employees of Vencor and its
Affiliates Amended and Restated effective as of March 1, 2000. Exhibit
10.7 to the Company's Form 10-Q for the quarterly period ended March
31, 2000 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.26 Amendment No. 1 to the Vencor Retirement Savings Plan dated September
26, 2000. Exhibit 10.8 to the Company's Form 10-Q for the quarterly
period ended September 30, 2000 (Comm. File No. 001-14057) is hereby
incorporated by reference.
73
Exhibit
Number Description of Document
------- -----------------------
10.27 Amendment No. 1 to the Retirement Savings Plan for Certain Employees
for Vencor and its Affiliates dated September 26, 2000. Exhibit 10.9
to the Company's Form 10-Q for the quarterly period ended September
30, 2000 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.28 Tax Allocation Agreement dated as of April 30, 1998 by and between
Vencor, Inc. and Ventas, Inc. Exhibit 10.9 to the Company's Form 10-Q
for the quarterly period ended June 30, 1998 (Comm. File No. 001-
14057) is hereby incorporated by reference.
10.29 Transition Services Agreement dated as of April 30, 1998 by and
between Vencor, Inc. and Ventas, Inc. Exhibit 10.10 to the Company's
Form 10-Q for the quarterly period ended June 30, 1998 (Comm. File No.
001-14057) is hereby incorporated by reference.
10.30 Agreement of Indemnity-Third Party Leases dated as of April 30, 1998
by and between Vencor, Inc. and its subsidiaries and Ventas, Inc.
Exhibit 10.11 to the Company's Form 10-Q for the quarterly period
ended June 30, 1998 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.31 Agreement of Indemnity-Third Party Contracts dated as of April 30,
1998 by and between Vencor, Inc. and its subsidiaries and Ventas, Inc.
Exhibit 10.12 to the Company's Form 10-Q for the quarterly period
ended June 30, 1998 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.32 Form of Indemnification Agreement between Vencor, Inc. and certain of
its officers and employees. Exhibit 10.31 to the Ventas, Inc. Form 10-
K for the year ended December 31, 1995 (Comm. File No. 1-10989) is
hereby incorporated by reference.
10.33 Amended and Restated Agreement and Plan of Merger. Appendix A to
Amendment No. 2 to the Ventas, Inc. Registration Statement on Form S-4
(Reg. No. 33-59345) is hereby incorporated by reference.
10.34 Agreement and Plan of Merger dated as of February 9, 1997 among
TheraTx, Incorporated, Vencor, Inc. and Peach Acquisition Corp.
("Peach"). Exhibit (c)(1) to the Statement on Schedule 14D-1 of
Ventas, Inc. and Peach, dated February 14, 1997 (Comm. File No. 1-
10989) is hereby incorporated by reference.
10.35 Amendment No. 1 to Agreement and Plan of Merger dated as of February
28, 1997 among TheraTx, Incorporated, Vencor, Inc. and Peach. Exhibit
(c)(3) of Amendment No. 2 to the Statement on Schedule 14D-1 of
Ventas, Inc. and Peach, dated March 3, 1997 (Comm. File No. 1-10989)
is hereby incorporated by reference.
10.36 Asset Purchase Agreement between Transitional Hospitals Corporation
and Behavioral Healthcare Corporation, dated October 22, 1996. Exhibit
99.1 to the Current Report on Form 8-K of Transitional dated October
22, 1996 (Comm. File No. 1-7008) is hereby incorporated by reference.
10.37 Agreement and Plan of Merger between Transitional Hospitals
Corporation and Behavioral Healthcare Corporation, dated October 22,
1996. Exhibit 99.2 to the Current Report on Form 8-K of Transitional
dated October 22, 1996 (Comm. File No. 1-7008) is hereby incorporated
by reference.
10.38 First Amendment to Asset Purchase Agreement between Transitional
Hospitals Corporation and Behavioral Healthcare Corporation, dated
November 30, 1996. Exhibit 99.1 to the Current Report on Form 8-K of
Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby
incorporated by reference.
10.39 Amendment to Agreement and Plan of Merger between Transitional
Hospitals Corporation and Behavioral Healthcare Corporation, dated
November 30, 1996. Exhibit 99.2 to the Current Report on Form 8-K of
Transitional dated December 16, 1996 (Comm. File No. 1-7008) is hereby
incorporated by reference.
10.40* Vencor, Inc. 1998 Incentive Compensation Plan. Exhibit 10.23 to the
Company's Registration Statement on Form S-4 (Reg. No. 333-57953) is
hereby incorporated by reference.
74
Exhibit
Number Description of Document
------- -----------------------
10.41* Vencor, Inc. 1998 Stock Option Plan for Non-Employee Directors.
Exhibit 10.24 to the Company's Registration Statement on Form S-4
(Reg. No. 333-57953) is hereby incorporated by reference.
10.42* Vencor, Inc. Deferred Compensation Plan dated April 30, 1998. Exhibit
10.25 to the Company's Registration Statement on Form S-4 (Reg. No.
333-57953) is hereby incorporated by reference.
10.43* Vencor, Inc. Supplemental Executive Retirement Plan dated January 1,
1998, as amended. Exhibit 10.27 to the Company's Registration
Statement on Form S-4 (Reg. No. 333-57953) is hereby incorporated by
reference.
10.44* Amendment No. Two to Supplemental Executive Retirement Plan dated as
of January 15, 1999. Exhibit 10.48 to the Company's Form 10-K for the
year ended December 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.45* Amendment No. Three to Supplemental Executive Retirement Plan dated as
of December 31, 1999. Exhibit 10.49 to the Company's Form 10-K for the
year ended December 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.46* Vencor, Inc. 2000 Long-Term Incentive Plan, dated effective as of
January 1, 2000.
10.47* Form of Vencor Operating, Inc. Change-in-Control Severance Agreement.
Exhibit 10.28 to the Company's Registration Statement on Form S-4
(Reg. No. 333-57953) is hereby incorporated by reference.
10.48* Form of Vencor, Inc. Promissory Note. Exhibit 10.29 to the Company's
Registration Statement on Form S-4 (Reg. No. 333-57953) is hereby
incorporated by reference.
10.49* Form of Non-Transferable Full Recourse Secured Promissory Note dated
as of September 28, 1998 made by certain executive officers in favor
of Vencor Operating, Inc. Exhibit 10.6 to the Company's Form 10-Q for
the quarterly period ended September 30, 1998 (Comm. File No. 001-
14057) is hereby incorporated by reference.
10.50* Employment Agreement dated as of February 12, 1999 between Vencor
Operating, Inc. and Edward L. Kuntz. Exhibit 10.3 to the Company's
Form 10-Q for the quarterly period ended March 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.51* Employment Agreement dated as of September 28, 1998 between Vencor
Operating, Inc. and Richard A. Schweinhart. Exhibit 10.57 to the
Company's Form 10-K for the year ended December 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.52* Employment Agreement dated as of July 28, 1998 between Vencor
Operating, Inc. and Richard E. Chapman. Exhibit 10.58 to the Company's
Form 10-K for the year ended December 31, 1999 (Comm. File No. 001-
14057) is hereby incorporated by reference.
10.53* Employment Agreement dated as of January 4, 1999 between Vencor
Operating, Inc. and Donald D. Finney. Exhibit 10.4 to the Company's
Form 10-Q for the quarterly period ended March 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.54* Amendment No. 1 to Employment Agreement dated as of November 5, 1999
between Vencor Operating, Inc. and Donald D. Finney. Exhibit 10.60 to
the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.55* Employment Agreement dated as of July 28, 1998 between Vencor
Operating, Inc. and Frank J. Battafarano. Exhibit 10.63 to the
Company's Form 10-K for the year ended December 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.56* Amendment to Employment Agreement dated as of September 28, 1998
between Vencor Operating, Inc. and Frank J. Battafarano. Exhibit 10.64
to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.57* Amendment No. 2 to Employment Agreement dated as of November 5, 1999
between Vencor Operating, Inc. and Frank J. Battafarano. Exhibit 10.65
to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
75
Exhibit
Number Description of Document
------- -----------------------
10.58* Employment Agreement dated as of July 28, 1998 between Vencor
Operating, Inc. and James H. Gillenwater, Jr. Exhibit 10.66 to the
Company's Form 10-K for the year ended December 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.59* Employment Agreement dated as of July 28, 1998 between Vencor
Operating, Inc. and M. Suzanne Riedman. Exhibit 10.67 to the Company's
Form 10-K for the year ended December 31, 1999 (Comm. File No. 001-
14057) is hereby incorporated by reference.
10.60* Amendment to Employment Agreement dated as of September 28, 1998
between Vencor Operating, Inc. and M. Suzanne Riedman. Exhibit 10.68
to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.61* Amendment No. 2 to Employment Agreement dated as of November 5, 1999
between Vencor Operating, Inc. and M. Suzanne Riedman. Exhibit 10.69
to the Company's Form 10-K for the year ended December 31, 1999 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.62* Employment Agreement dated as of July 28, 1998 between Vencor
Operating, Inc. and Richard A. Lechleiter. Exhibit 10.70 to the
Company's Form 10-K for the year ended December 31, 1999 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.63* Amendment to Employment Agreement dated as of September 28, 1998
between Vencor Operating, Inc. and Richard A. Lechleiter. Exhibit
10.71 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.64* Amendment No. 2 to Employment Agreement dated as of November 5, 1999
between Vencor Operating, Inc. and Richard A. Lechleiter. Exhibit
10.72 to the Company's Form 10-K for the year ended December 31, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.65* Employment Agreement dated as of November 9, 1998 between Vencor
Operating, Inc. and William M. Altman.
10.66* Form of Vencor, Inc. Retention Agreement. Exhibit 10.3 to the
Company's Form 10-Q for the quarterly period ended June 30, 1999
(Comm. File No. 001-14057) is hereby incorporated by reference.
10.67* Form of Agreement regarding Preferred Stock dated as of August 17,
1999 between Vencor Operating, Inc., Vencor, Inc. and certain officers
of the Company. Exhibit 10.9 to the Company's Form 10-Q for the
quarterly period ended September 30, 1999 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.68 Distribution Agreement between the Company and Ventas, Inc. Exhibit
10.2 to the Company's Form 10, as amended, dated April 27, 1998 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.69 Form of Master Lease Agreement between the Company and Ventas, Inc.
Exhibit 10.3 to the Company's Form 10, as amended, dated April 27,
1998 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.70 Form of First Amendment to Master Lease Agreement dated December 31,
1998 between the Company and Ventas, Inc. Exhibit 10.47 to the
Company's Form 10-K for the year ended December 31, 1998 (Comm. File
No. 001-14057) is hereby incorporated by reference.
10.71 Second Amendment to Master Lease Agreement No. 1 dated April 12, 1999
by and among Ventas, Inc., Ventas Realty, Limited Partnership, Vencor
Operating, Inc. and the Company. Exhibit 10.48 to the Company's Form
10-K for the year ended December 31, 1998 (Comm. File No. 001-14057)
is hereby incorporated by reference.
76
Exhibit
Number Description of Document
------- -----------------------
10.72 Second Amendment to Master Lease Agreement No. 2 dated April 12, 1999
by and among Ventas, Inc., Ventas Realty, Limited Partnership, Vencor
Operating, Inc. and the Company. Exhibit 10.49 to the Company's Form
10-K for the year ended December 31, 1998 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.73 Second Amendment to Master Lease Agreement No. 3 dated April 12, 1999
by and among Ventas, Inc., Ventas Realty, Limited Partnership, Vencor
Operating, Inc. and the Company. Exhibit 10.50 to the Company's Form
10-K for the year ended December 31, 1998 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.74 Second Amendment to Master Lease Agreement No. 4 dated April 12, 1999
by and among Ventas, Inc., Ventas Realty, Limited Partnership, Vencor
Operating, Inc. and the Company. Exhibit 10.51 to the Company's Form
10-K for the year ended December 31, 1998 (Comm. File No. 001-14057)
is hereby incorporated by reference.
10.75 Development Agreement between the Company and Ventas, Inc. Exhibit
10.4 to the Company's Form 10, as amended, dated April 27, 1998 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.76 Participation Agreement between the Company and Ventas, Inc. Exhibit
10.5 to the Company's Form 10, as amended, dated April 27, 1998 (Comm.
File No. 001-14057) is hereby incorporated by reference.
10.77 Agreement and Plan of Reorganization between the Company and Ventas,
Inc. Exhibit 10.1 to the Company's Form 10, as amended, dated April
27, 1998 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.78 Standstill Agreement dated March 31, 1999 between the Company and
Ventas, Inc. Exhibit 99.3 to the Current Report on Form 8-K of the
Company dated March 31, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.79 Second Standstill Agreement dated April 12, 1999 between the Company
and Ventas, Inc. Exhibit 10.57 to the Company's Form 10-K for the year
ended December 31, 1998 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.80 Amendment Number 1 to the Second Standstill Agreement dated April 12,
1999 dated as of May 5, 1999 between the Company and Ventas, Inc.
Exhibit 10.12 to the Company's Form 10-Q for the quarterly period
ended March 31, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.81 Tolling Agreement dated April 12, 1999 between the Company and Ventas,
Inc. Exhibit 10.58 to the Company's Form 10-K for the year ended
December 31, 1998 (Comm. File No. 001-14057) is hereby incorporated by
reference.
10.82 Amendment Number 2 to the Second Standstill Agreement dated April 12,
1999 and Amendment Number 1 to the Tolling Agreement dated April 12,
1999 dated as of May 8, 1999 between the Company and Ventas, Inc.
Exhibit 10.13 to the Company's Form 10-Q for the quarterly period
ended March 31, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.83 Amendment Number 4 to the Second Standstill Agreement dated April 12,
1999 and Amendment Number 3 to the Tolling Agreement dated April 12,
1999. Exhibit 99.2 to the Current Report on Form 8-K of the Company
dated June 7, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.84 Amendment Number 5 to the Second Standstill Agreement dated April 12,
1999 and Amendment Number 4 to the Tolling Agreement dated April 12,
1999. Exhibit 99.2 to the Current Report on Form 8-K of the Company
dated July 7, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
77
Exhibit
Number Description of Document
------- -----------------------
10.85 Amendment Number 6 to the Second Standstill Agreement dated April 12,
1999 and Amendment Number 5 to the Tolling Agreement dated April 12,
1999. Exhibit 10.15 to the Company's Form 10-Q for the quarterly
period ended June 30, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.86 Amendment Number 7 to the Second Standstill Agreement dated April 12,
1999 and Amendment Number 6 to the Tolling Agreement dated April 12,
1999. Exhibit 10.6 to the Company's Form 10-Q for the quarterly period
ended September 30, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
10.87 Stipulation Agreement by and among Ventas, Inc., Ventas Realty,
Limited Partnership, Vencor Operating, Inc. and Vencor, Inc. Exhibit
10.7 to the Company's Form 10-Q for the quarterly period ended
September 30, 1999 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.88 Tax Stipulation by and among Vencor, Inc., Vencor Operating, Inc. and
each of Vencor's subsidiaries a party thereto, Ventas, Inc., Ventas
Realty, Limited Partnership and Ventas LP Realty, L.L.C. Exhibit 10.6
to the Company's Form 10-Q for the quarterly period ended June 30,
2000 (Comm. File No. 001-14057) is hereby incorporated by reference.
10.89 Corporate Integrity Agreement between the Office of Inspector General
of the Department of Health and Human Services and Vencor, Inc.
Exhibit 10.7 to the Company's Form 10-Q for the quarterly period ended
September 30, 2000 (Comm. File No. 001-14057) is hereby incorporated
by reference.
10.90 Charter for the Audit and Compliance Committee of the Board of
Directors of Vencor, Inc. effective as of November 8, 2000.
10.91 Other Debt Instruments--Copies of debt instruments for which the
related debt is less than 10% of total assets will be furnished to the
Commission upon request.
16 Letter from Ernst & Young LLP regarding a change in certifying
accountants. Exhibit 16 to the Current Report on Form 8-K of the
Company dated November 2, 1999 (Comm. File No. 001-14057) is hereby
incorporated by reference.
21 List of Subsidiaries.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Ernst & Young LLP.
--------
* Compensatory plan or arrangement required to be filed as an exhibit pursuant
to Item 14(c) of Annual Report on Form 10-K.
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on October 2, 2000 announcing
that it had filed its first plan of reorganization with the Bankruptcy Court.
The Company filed a Current Report on Form 8-K on October 26, 2000 announcing
that the Bankruptcy Court had approved an amendment to the DIP Financing to
extend its maturity until January 31, 2001. This Current Report also reported
that the Bankruptcy Court also approved an amendment to the commitment letter
among the Company and certain of the DIP Lenders to extend the date by which
Bankruptcy Court approval must be obtained for the commitment letter to be
effective through January 31, 2001.
(c) Exhibits.
The response to this portion of Item 14 is submitted as a separate section
of this Report.
(d) Financial Statement Schedules.
The response to this portion of Item 14 is included in appendix page F-49 of
this Report.
78
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: August 28, 2001 Kindred Healthcare, Inc.
/s/ Edward L. Kuntz
By: ______________________________
Edward L. Kuntz
Chairman of the Board,
Chief Executive Officer and
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ James Bolin Director August 28, 2001
______________________________________
James Bolin
/s/ Michael J. Embler Director August 28, 2001
______________________________________
Michael J. Embler
/s/ Garry N. Garrison Director August 28, 2001
______________________________________
Garry N. Garrison
/s/ Isaac Kaufman Director August 28, 2001
______________________________________
Isaac Kaufman
Director
______________________________________
John H. Klein
/s/ Edward L. Kuntz Chairman of the Board, Chief August 28, 2001
______________________________________ Executive Officer and
Edward L. Kuntz President (Principal
Executive Officer)
/s/ Richard A. Lechleiter Vice President, Finance, August 28, 2001
______________________________________ Corporate Controller and
Richard A. Lechleiter Treasurer (Principal
Accounting Officer)
/s/ Richard A. Schweinhart Senior Vice President and August 28, 2001
______________________________________ Chief Financial Officer
Richard A. Schweinhart (Principal Financial
Officer)
Director
______________________________________
David Tepper
79
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Page
----
Report of PricewaterhouseCoopers LLP...................................... F-2
Report of Ernst & Young LLP............................................... F-3
Consolidated Financial Statements (restated):
Consolidated Statement of Operations for the years ended December 31,
2000, 1999 and 1998.................................................... F-4
Consolidated Balance Sheet, December 31, 2000 and 1999.................. F-5
Consolidated Statement of Stockholders' Equity (Deficit) for the years
ended December 31, 2000, 1999 and 1998................................. F-6
Consolidated Statement of Cash Flows for the years ended December 31,
2000, 1999 and 1998.................................................... F-7
Notes to Consolidated Financial Statements.............................. F-8
Quarterly Consolidated Financial Information (Unaudited)................ F-48
Financial Statement Schedule (a):
Schedule II--Valuation and Qualifying Accounts for the years ended
December 31, 2000,
1999 and 1998.......................................................... F-49
--------
(a) All other schedules have been omitted because the required information is
not present or not present in material amounts.
F-1
REPORT OF PRICEWATERHOUSECOOPERS LLP
To the Board of Directors and Stockholders
of Kindred Healthcare, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index, after the restatement described in Note 2, present fairly,
in all material respects, the financial position of Kindred Healthcare, Inc.
(formerly Vencor, Inc.) and its subsidiaries at December 31, 2000 and
December 31, 1999, and the results of their operations and their cash flows for
each of the two years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our original report, we included an explanatory paragraph regarding to the
Company's ability to continue as a going concern. As discussed in Note 22 to
the consolidated financial statements, the Company emerged from bankruptcy
effective April 20, 2001, alleviating substantial doubt about the Company's
ability to continue as a going concern.
/s/ PricewaterhouseCoopers LLP
Louisville, Kentucky
March 16, 2001, except for Note 22,
as to which the date is April 20,
2001, and Notes 2 and 10, as to
which the date is August 22, 2001
F-2
REPORT OF ERNST & YOUNG LLP
To the Board of Directors and Stockholders
Kindred Healthcare, Inc.
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows of Kindred Healthcare, Inc. (formerly
Vencor, Inc.) for the year ended December 31, 1998. Our audit also included the
1998 financial statement schedule listed on page F-1. These financial
statements and schedule for 1998 are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Kindred Healthcare, Inc. at December 31, 1998 and the consolidated results of
its operations and its cash flows for the year ended December 31, 1998 in
conformity with accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule for 1998, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
The accompanying 1998 consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As more fully
described in Note 3, the Company incurred a net loss in 1998 and was not in
compliance with certain covenants of a loan agreement at December 31, 1998. In
addition, the Company had a working capital deficiency at December 31, 1998.
These conditions raise substantial doubts about the Company's ability to
continue as a going concern. The 1998 consolidated financial statements do not
include adjustments, if any, to reflect the possible future effects on the
recoverability and classification of recorded asset amounts or the amounts and
classifications of liabilities that may result from the outcome of this
uncertainty.
/s/ Ernst & Young LLP
Louisville, Kentucky
April 13, 1999, except for Note 2,
as to which the date is August 22,
2001
F-3
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands, except per share amounts)
(Restated--see Note 2)
----------------------------------
2000 1999 1998
---------- ---------- ----------
Revenues................................... $2,888,542 $2,665,641 $2,999,739
---------- ---------- ----------
Salaries, wages and benefits............... 1,623,955 1,566,227 1,753,023
Supplies................................... 374,540 347,789 340,053
Rent....................................... 307,809 305,120 234,144
Other operating expenses................... 503,770 964,413 947,889
Depreciation and amortization.............. 73,545 93,196 124,617
Interest expense........................... 60,431 80,442 107,008
Investment income.......................... (5,393) (5,188) (4,688)
---------- ---------- ----------
2,938,657 3,351,999 3,502,046
---------- ---------- ----------
Loss before reorganization costs and
income taxes.............................. (50,115) (686,358) (502,307)
Reorganization costs....................... 12,636 18,606 -
---------- ---------- ----------
Loss before income taxes................... (62,751) (704,964) (502,307)
Provision for income taxes................. 2,000 500 76,099
---------- ---------- ----------
Loss from operations....................... (64,751) (705,464) (578,406)
Cumulative effect of change in accounting
for start-up costs........................ - (8,923) -
Extraordinary loss on extinguishment of
debt, net of income tax
benefit of $48,789........................ - - (77,937)
---------- ---------- ----------
Net loss............................. (64,751) (714,387) (656,343)
Preferred stock dividend requirements...... (1,046) (1,046) (697)
---------- ---------- ----------
Loss available to common
stockholders........................ $ (65,797) $ (715,433) $ (657,040)
========== ========== ==========
Loss per common share:
Basic:
Loss from operations................... $ (0.94) $ (10.03) $ (8.47)
Cumulative effect of change in
accounting for start-up costs......... - (0.13) -
Extraordinary loss on extinguishment
of debt............................... - - (1.14)
---------- ---------- ----------
Net loss............................. $ (0.94) $ (10.16) $ (9.61)
========== ========== ==========
Diluted:
Loss from operations................... $ (0.94) $ (10.03) $ (8.47)
Cumulative effect of change in
accounting for start-up costs......... - (0.13) -
Extraordinary loss on extinguishment
of debt............................... - - (1.14)
---------- ---------- ----------
Net loss............................. $ (0.94) $ (10.16) $ (9.61)
========== ========== ==========
Shares used in computing loss per common
share:
Basic.................................... 70,229 70,406 68,343
Diluted.................................. 70,229 70,406 68,343
See accompanying notes.
F-4
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2000 AND 1999
(In thousands, except per share amounts)
(Restated)
------------------------
2000 1999
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 184,642 $ 148,350
Accounts receivable less allowance for loss of
$139,445--2000 and $180,055--1999................. 322,483 324,135
Inventories........................................ 29,707 28,956
Insurance subsidiary investments................... 62,453 16,483
Other.............................................. 96,567 73,960
----------- -----------
695,852 591,884
Property and equipment, at cost:
Land............................................... 26,380 26,002
Buildings.......................................... 248,175 215,508
Equipment.......................................... 389,824 330,925
Construction in progress (estimated cost to
complete and equip after December 31, 2000--$8
million).......................................... 29,207 42,725
----------- -----------
693,586 615,160
Accumulated depreciation........................... (300,881) (243,526)
----------- -----------
392,705 371,634
Goodwill less accumulated amortization of $28,779--
2000 and $17,817--1999.............................. 159,277 173,818
Other................................................ 86,580 98,638
----------- -----------
$ 1,334,414 $ 1,235,974
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable................................... $ 115,468 $ 101,219
Salaries, wages and other compensation............. 184,860 159,482
Due to third-party payors.......................... 44,561 52,205
Other accrued liabilities.......................... 83,802 83,967
----------- -----------
428,691 396,873
Professional liability risks......................... 101,209 72,785
Deferred credits and other liabilities............... 14,132 11,178
Liabilities subject to compromise.................... 1,260,373 1,159,417
Series A preferred stock (subject to compromise)..... 1,743 1,743
Contingencies
Stockholders' equity (deficit):
Preferred stock, $1.00 par value; authorized 10,000
shares; none issued and outstanding............... - -
Common stock, $0.25 par value; authorized 180,000
shares; issued 70,261 shares--2000 and
70,278 shares--1999............................... 17,565 17,570
Capital in excess of par value..................... 667,168 667,078
Accumulated deficit................................ (1,156,467) (1,090,670)
----------- -----------
(471,734) (406,022)
----------- -----------
$ 1,334,414 $ 1,235,974
=========== ===========
See accompanying notes.
F-5
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands)
Shares
---------------- Par Capital
Common Value in Retained Common
Common Treasury Common Excess of Earnings Treasury
Stock Stock Stock Par Value (Deficit) Stock Total
------ -------- ------- --------- ----------- --------- ---------
(Restated)
Balances, December 31,
1997................... 73,470 (6,159) $18,368 $ 766,078 $ 281,803 $(160,899) $ 905,350
Net loss............... (656,343) (656,343)
Non-cash spin-off
transactions with
Ventas, Inc.:
Property and equipment,
net................... (953,534) (953,534)
Long-term debt......... 991,768 991,768
Common treasury stock.. (5,917) 5,917 (1,479) (156,390) 157,869 -
Series A preferred
stock................. (17,700) (17,700)
Deferred income taxes.. 15,907 15,907
Issuance of common
stock in connection
with employee benefit
plans................. 2,593 242 648 14,396 3,030 18,074
Preferred stock
dividend
requirements.......... (697) (697)
Other.................. 4,922 4,922
------ ------ ------- --------- ----------- --------- ---------
Balances, December 31,
1998................... 70,146 - 17,537 665,447 (375,237) - 307,747
Net loss............... (714,387) (714,387)
Issuance of common
stock in connection
with employee benefit
plans................. 132 33 309 342
Preferred stock
dividend
requirements.......... (1,046) (1,046)
Other.................. 1,322 1,322
------ ------ ------- --------- ----------- --------- ---------
Balances, December 31,
1999................... 70,278 - 17,570 667,078 (1,090,670) - (406,022)
Net loss............... (64,751) - (64,751)
Issuance (forfeiture)
of common stock in
connection with
employee benefit
plans................. (17) (5) 35 30
Preferred stock
dividend
requirements.......... (1,046) (1,046)
Other.................. 55 55
------ ------ ------- --------- ----------- --------- ---------
Balances, December 31,
2000................... 70,261 - $17,565 $ 667,168 $(1,156,467) $ - $(471,734)
====== ====== ======= ========= =========== ========= =========
See accompanying notes.
F-6
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands)
(Restated)
-------------------------------
2000 1999 1998
--------- --------- ---------
Cash flows from operating activities:
Net loss..................................... $ (64,751) $(714,387) $(656,343)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization................ 73,545 93,196 124,617
Provision for doubtful accounts.............. 28,911 114,578 55,561
Deferred income taxes........................ - - 71,496
Extraordinary loss on extinguishment of
debt........................................ - - 126,726
Unusual transactions......................... 4,701 411,615 506,003
Gain on sale of investment in Atria
Communities, Inc............................ - - (98,461)
Reorganization costs......................... 12,636 18,606 -
Cumulative effect of change in accounting
for start-up costs.......................... - 8,923 -
Other........................................ 17,166 19,247 2,173
Change in operating assets and liabilities:
Accounts receivable......................... (21,590) 90,428 43,649
Inventories and other assets................ (20,154) 5,868 (11,920)
Accounts payable............................ 15,639 25,580 52,437
Income taxes................................ 2,961 6,431 (17,167)
Due to third-party payors................... (4,278) 99,370 155,333
Other accrued liabilities................... 149,279 67,616 (30,908)
--------- --------- ---------
Net cash provided by operating activities
before reorganization costs............... 194,065 247,071 323,196
Payment of reorganization costs.............. (8,525) (15,684) -
--------- --------- ---------
Net cash provided by operating activities.. 185,540 231,387 323,196
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment........... (79,988) (111,493) (267,288)
Other acquisitions........................... - - (24,227)
Sale of investment in Atria Communities,
Inc......................................... - - 177,500
Sale of investment in Colorado MEDtech,
Inc......................................... - - 22,001
Sale of other assets......................... 15,241 12,289 37,827
Surety bond deposits......................... (4,647) (17,213) -
Series A preferred stock loans............... - - (15,930)
Net change in investments.................... (46,904) 6,377 13,164
Other........................................ 1,731 (2,548) (5,203)
--------- --------- ---------
Net cash used in investing activities...... (114,567) (112,588) (62,156)
--------- --------- ---------
Cash flows from financing activities:
Net change in borrowings under revolving
lines of credit............................. - 55,000 (251,146)
Issuance of long-term debt................... - - 700,000
Net proceeds from senior subordinated notes
offerings................................... - - 294,000
Redemption of senior subordinated notes...... - - (732,547)
Repayment of long-term debt.................. (18,696) (26,776) (281,316)
Payment of debtor-in-possession deferred
financing costs............................. (1,226) (3,752) -
Payment of other deferred financing costs.... - (2,068) (11,334)
Other........................................ (14,759) (27,404) 227
--------- --------- ---------
Net cash used in financing activities...... (34,681) (5,000) (282,116)
--------- --------- ---------
Change in cash and cash equivalents........... 36,292 113,799 (21,076)
Cash and cash equivalents at beginning of
period....................................... 148,350 34,551 55,627
--------- --------- ---------
Cash and cash equivalents at end of period.... $ 184,642 $ 148,350 $ 34,551
========= ========= =========
Supplemental information:
Interest payments............................ $ 11,930 $ 35,783 $ 129,395
Income tax refunds........................... (713) (5,931) (31,576)
See accompanying notes.
F-7
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--ACCOUNTING POLICIES
Reporting Entity
Kindred Healthcare, Inc. ("Kindred" or the "Company") (formerly Vencor, Inc.)
provides long-term healthcare services primarily through the operation of
nursing centers and hospitals. At December 31, 2000, the Company's health
services division operated 312 nursing centers (40,189 licensed beds) in 31
states and a rehabilitation therapy business. The Company's hospital division
operated 56 hospitals (4,886 licensed beds) in 23 states and an institutional
pharmacy business.
The Company and substantially all of its subsidiaries filed voluntary
petitions for protection under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Code") on September 13, 1999. The Company currently is
operating its businesses as a debtor-in-possession subject to the jurisdiction
of the United States Bankruptcy Court in Delaware (the "Bankruptcy Court").
Accordingly, the consolidated financial statements of the Company have been
prepared in accordance with the American Institute of Certified Public
Accountants Statement of Position ("SOP") 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7") and
generally accepted accounting principles applicable to a going concern, which
assumes that assets will be realized and liabilities will be discharged in the
normal course of business. The consolidated financial statements do not include
any adjustments that might result from the resolution of the Chapter 11 Cases
(as defined) or other matters discussed in the accompanying notes. The
Company's recent operating losses, liquidity issues and the Chapter 11 Cases
raise substantial doubt about the Company's ability to continue as a going
concern. The ability of the Company to continue as a going concern and the
appropriateness of using the going concern basis of accounting are dependent
upon, among other things, (a) the Company's ability to comply with the terms of
the DIP Financing (as defined), (b) consummation of the Amended Plan (as
defined), (c) the Company's ability to achieve profitable operations after such
consummation, and (d) the Company's ability to generate sufficient cash from
operations to meet its obligations. The Amended Plan and other actions during
the Chapter 11 Cases could change materially the amounts currently recorded in
the consolidated financial statements. See Note 3.
On May 1, 1998, Ventas, Inc. ("Ventas" or the "Company's predecessor")
completed the spin-off of its healthcare operations to its stockholders through
the distribution of the Company's common stock (the "Spin-off"). Ventas
retained ownership of substantially all of its real property and leases such
real property to the Company under four master lease agreements. In
anticipation of the Spin-off, the Company was incorporated on March 27, 1998 as
a Delaware corporation. For accounting purposes, the consolidated historical
financial statements of Ventas became the Company's historical financial
statements following the Spin-off. Any discussion concerning events prior to
May 1, 1998 refers to the Company's business as it was conducted by Ventas
prior to the Spin-off. See Notes 3 and 17.
Basis of Presentation
The consolidated financial statements include all subsidiaries. Significant
intercompany transactions have been eliminated. Investments in affiliates in
which the Company has a 50% or less interest are accounted for by either the
equity or cost method.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and include amounts
based upon the estimates and judgments of management. Actual amounts may differ
from these estimates.
Impact of Recent Accounting Pronouncements
Beginning in 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive
Income," ("SFAS 130"), which established new rules for the
F-8
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 1--ACCOUNTING POLICIES (Continued)
Impact of Recent Accounting Pronouncements (Continued)
reporting of comprehensive income and its components. SFAS 130 requires, among
other things, unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported as changes in common
stockholders' equity, to be disclosed as other comprehensive income. There were
no significant comprehensive income items for the years ended December 31,
2000, 1999 and 1998.
Beginning in 1998, the Company adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
requires revised disclosures for segments of a company based upon management's
approach to defining business operating segments. See Note 8.
Effective January 1, 1999, the Company adopted SOP 98-5, "Reporting on the
Costs of Start-Up Activities" ("SOP 98-5"), which requires the Company to
expense start-up costs, including organizational costs, as incurred. In
accordance with the provisions of SOP 98-5, the Company wrote off $8.9 million
of such unamortized costs as a cumulative effect of a change in accounting
principle in the first quarter of 1999. The pro forma effect of the change in
accounting for start-up costs, assuming the change occurred on January 1, 1998,
was not significant.
In the first quarter of 1999, the Company adopted SOP 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP
98-1"). SOP 98-1 provides guidance on accounting for the costs of computer
software developed or obtained for internal use. The adoption of SOP 98-1 did
not have a material effect on the Company's consolidated financial position or
results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). SAB 101 provides guidance on revenue recognition and related
disclosures and was effective beginning October 1, 2000. The Company was
previously following the requirements provided under SAB 101 and, accordingly,
the implementation of this pronouncement had no impact on the Company's
financial position or results of operations.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS
133") which was required to be adopted in fiscal years beginning after June 15,
1999. In June 1999, FASB delayed the effective date of SFAS 133 for one year.
Management has determined that the adoption of SFAS 133 on January 1, 2001 will
not have a material impact on the Company's financial position or results of
operations.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year presentation.
Revenues
Revenues are recorded based upon estimated amounts due from patients and
third-party payors for healthcare services provided, including anticipated
settlements under reimbursement agreements with Medicare, Medicaid and other
third-party payors.
A summary of revenues by payor type follows (in thousands):
2000 1999 1998
---------- ---------- ----------
Medicare................................. $1,050,758 $ 918,395 $1,038,669
Medicaid................................. 925,356 902,032 869,923
Private and other........................ 969,557 906,849 1,136,828
---------- ---------- ----------
2,945,671 2,727,276 3,045,420
Elimination.............................. (57,129) (61,635) (45,681)
---------- ---------- ----------
$2,888,542 $2,665,641 $2,999,739
========== ========== ==========
F-9
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 1--ACCOUNTING POLICIES (Continued)
Cash and Cash Equivalents
Cash and cash equivalents include unrestricted highly liquid investments with
an original maturity of three months or less when purchased. Carrying values of
cash and cash equivalents approximate fair value due to the short-term nature
of these instruments.
Accounts Receivable
Accounts receivable consist primarily of amounts due from the Medicare and
Medicaid programs, other government programs, managed care health plans,
commercial insurance companies and individual patients. Amounts recorded
include estimated provisions for loss related to uncollectible accounts and
disputed items that have continuing significance, such as third-party
reimbursements that continue to be claimed in current cost reports.
Inventories
Inventories consist primarily of medical supplies and are stated at the lower
of cost (first-in, first-out) or market.
Property and Equipment
Depreciation expense, computed by the straight-line method, was $60.9 million
in 2000, $68.9 million in 1999 and $90.9 million in 1998. Depreciation rates
for buildings range generally from 20 to 45 years. Estimated useful lives of
equipment vary from 5 to 15 years.
Goodwill
Effective January 1, 2000, costs in excess of the fair value of identifiable
net assets of acquired entities are amortized using the straight-line method
principally over 20 years. Prior thereto, such costs were amortized over 40
years. Amortization expense recorded for 2000, 1999 and 1998 totaled $11.7
million, $23.3 million and $27.2 million, respectively.
Effective October 1, 1998, the Company reduced the amortization period for
goodwill related to its rehabilitation therapy business to seven years. In the
fourth quarter of 1999, in connection with the realignment of its former
Vencare division, the Company wrote off all of the goodwill associated with its
rehabilitation therapy business. See Note 4.
Long-Lived Assets
The Company regularly reviews the carrying value of certain long-lived assets
and the related identifiable intangible assets with respect to any events or
circumstances that indicate impairment or adjustment to the amortization
period. If such circumstances suggest the recorded amounts cannot be recovered,
calculated based upon estimated future cash flows (undiscounted), the carrying
values of such assets are reduced to fair value. See Note 6.
Professional Liability Risks
Provisions for loss for professional liability risks are based upon
actuarially determined estimates. To the extent that subsequent claims
information varies from management's estimates, earnings are charged or
credited.
F-10
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 1--ACCOUNTING POLICIES (Continued)
Derivative Instruments
Prior to May 15, 2000, the Company was a party to interest rate swap
agreements that eliminated the impact of changes in interest rates on certain
outstanding floating rate debt. Each interest rate swap agreement was
associated with all or a portion of the principal balance of a specific debt
obligation. These agreements involved the exchange of amounts based on variable
rates for amounts based on fixed interest rates over the life of the agreement,
without an exchange of the notional amount upon which the payments were based.
The differential paid or received as interest rates changed was accrued and
recognized as an adjustment of interest expense related to the debt, and the
related amount payable to or receivable from counterparties was included in
accrued interest. The fair values of the swap agreements were not recognized in
the consolidated financial statements. Gains and losses on terminations of
interest rate swap agreements were deferred (included in other assets) and
amortized as an adjustment to interest expense over the remaining term of the
original contract life of the terminated swap agreement.
Earnings per Common Share
Basic earnings per common share are based upon the weighted average number of
common shares outstanding. No incremental shares are included in the
calculations of the diluted loss per common share since the result would be
antidilutive.
NOTE 2--RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS
On August 14, 2001, the Company announced that it will restate certain of its
previously issued consolidated financial statements. The Company recently
determined that an oversight related to the allowance for professional
liability risks had occurred in its consolidated financial statements beginning
in 1998. The oversight resulted in the understatement of the provision for
professional liability claims in 1998, 1999 and 2000 because the Company did
not record a reserve for claims incurred but not reported at the respective
balance sheet dates. The cumulative understatement of professional liability
claims reserves approximated $5 million at December 31, 1998, $28 million at
December 31, 1999 and $39 million at December 31, 2000. The restatement had no
effect on previously reported cash flows from operations.
The consolidated financial statements included herein amend those previously
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2000. Consolidated financial statement information and related
disclosures included in these amended financial statements reflect, where
appropriate, changes resulting from the restatement.
F-11
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 2--RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (Continued)
The effect of the restatement on the Company's previously issued audited
consolidated financial statements follows (in thousands, except per share
amounts):
For the year ended December 31,
---------------------------------------------------------------------------
2000 1999 1998
------------------------ ------------------------ -----------------------
As As
previously As previously As As previously As
reported restated reported restated reported restated
----------- ----------- ----------- ----------- ------------- ---------
Loss from operations.... $ (53,582) $ (64,751) $ (683,249) $ (705,464) $(572,908) $(578,406)
Net loss................ (53,582) (64,751) (692,172) (714,387) (650,845) (656,343)
Loss per common share:
Basic:
Loss from operations.. $ (0.78) $ (0.94) $ (9.72) $ (10.03) $ (8.39) $ (8.47)
Net loss.............. (0.78) (0.94) (9.85) (10.16) (9.53) (9.61)
Diluted:
Loss from operations.. $ (0.78) $ (0.94) $ (9.72) $ (10.03) $ (8.39) $ (8.47)
Net loss.............. (0.78) (0.94) (9.85) (10.16) (9.53) (9.61)
December 31, 2000 December 31, 1999
------------------------ ------------------------
As As
previously As previously As
reported restated reported restated
----------- ----------- ----------- -----------
Professional liability
risks.................. $ 62,327 $ 101,209 $ 45,072 $ 72,785
Total liabilities....... 1,765,523 1,804,405 1,612,540 1,640,253
Accumulated deficit..... (1,117,585) (1,156,467) (1,062,957) (1,090,670)
Stockholders' deficit... (432,852) (471,734) (378,309) (406,022)
The Company has revised its professional liability risks disclosure in Note
10 for the impact of the restatement.
In addition, in Note 12, the Company has revised its disclosure of future
minimum lease payments under non-cancelable operating leases to exclude
contingent rentals.
NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 cases have been consolidated for purposes of joint
administration under Case Nos. 99-3199 (MFW) through 99-3327 (MFW)
(collectively, the "Chapter 11 Cases"). The Company currently is operating its
businesses as a debtor-in-possession subject to the jurisdiction of the
Bankruptcy Court.
On March 1, 2001, the Bankruptcy Court approved the Company's fourth amended
plan of reorganization filed with the Bankruptcy Court on December 14, 2000, as
modified at the confirmation hearing (the "Amended Plan"). The order confirming
the Amended Plan was entered on March 16, 2001. The Amended Plan must be
effective no later than May 1, 2001.
In connection with the confirmation hearing, the Company entered into a
commitment letter for a $120 million senior exit facility with a lending group
led by Morgan Guaranty Trust Company of New York (the "Exit Facility"). The
Exit Facility will be available to fund the Company's obligations under the
Amended Plan and its ongoing operations following emergence from bankruptcy.
F-12
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
The consummation of the Amended Plan is subject to a number of material
conditions including, without limitation, the negotiation and execution of
definitive agreements for the Exit Facility. There can be no assurance that the
Amended Plan will be consummated. See Notes 21 and 22.
In connection with the Chapter 11 Cases, the Company entered into a $100
million debtor-in-possession financing agreement (the "DIP Financing"). The
Bankruptcy Court granted final approval of the DIP Financing on October 1,
1999. The DIP Financing was initially comprised of a $75 million tranche A
revolving loan (the "Tranche A Loan") and a $25 million tranche B revolving
loan (the "Tranche B Loan"). Interest is payable at prime plus 2 1/2% on the
Tranche A Loan and prime plus 4 1/2% on the Tranche B Loan.
Available aggregate borrowings under the Tranche A Loan were initially
limited to $45 million in September 1999 and increased to $65 million in
October 1999, $70 million in November 1999 and $75 million thereafter. Pursuant
to the most recent amendment to the DIP Financing, the aggregate borrowing
limitations under the Tranche A Loan are limited to approximately $48 million
until maturity and are reduced for asset sales made by the Company. In
addition, Tranche B Loan aggregate borrowings are limited to $23 million as a
result of the most recent amendment to the DIP Financing. Borrowings under the
Tranche B Loan require the approval of lenders holding at least 75% of the
credit exposure under the DIP Financing. The DIP Financing is secured by
substantially all of the assets of the Company and its subsidiaries, including
certain owned real property. The DIP Financing contains standard
representations and warranties and other affirmative and restrictive covenants.
At December 31, 2000, there were no outstanding borrowings under the DIP
Financing.
Since the consummation of the DIP Financing, the Company and the lenders
under the DIP Financing (the "DIP Lenders") have agreed to several amendments
to the DIP Financing. In the most recent amendment to the DIP Financing, the
parties agreed, among other things, to extend the maturity date of the DIP
Financing until March 31, 2001 and to revise and update certain financial
covenants. In addition, the most recent amendment extends the period of time
for the Company to file the appropriate pleadings to request confirmation and
consummation of the Amended Plan through March 31, 2001. At December 31, 2000,
the Company was in compliance with the terms of the DIP Financing.
The Company expects to terminate the DIP Financing on or prior to the
effective date of the Amended Plan.
Events Leading to Reorganization
The Company reported a net loss from operations in 1998 aggregating $578
million, resulting in certain financial covenant violations under the Company's
$1.0 billion bank credit facility (the "Credit Agreement"). Prior to the
commencement of the Chapter 11 Cases, the Company received a series of
temporary waivers of these covenant violations. The waivers generally included
certain borrowing limitations under the $300 million revolving credit portion
of the Credit Agreement. The final waiver was scheduled to expire on September
24, 1999.
The Company was informed on April 9, 1999 by the Health Care Financing
Administration ("HCFA") that the Medicare program had made a demand for
repayment of approximately $90 million of reimbursement overpayments. On April
21, 1999, the Company reached an agreement with HCFA to extend the repayment of
such amounts over 60 monthly installments (the "HCFA Agreement"). Under the
HCFA Agreement, non-interest bearing monthly payments of approximately $1.5
million commenced in May 1999. Beginning in December 1999, interest began to
accrue on the balance of the overpayments at a statutory rate approximating
13.4%, resulting in a monthly payment of approximately $2.0 million through
March 2004. If the Company is
F-13
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Events Leading to Reorganization (Continued)
delinquent with two consecutive payments, the HCFA Agreement will be defaulted
and all subsequent Medicare reimbursement payments to the Company may be
withheld. Amounts due under the HCFA Agreement aggregated $63.4 million at
December 31, 2000 and have been classified as liabilities subject to compromise
in the Company's consolidated balance sheet. The Company has received
Bankruptcy Court approval to continue to make the monthly payments under the
HCFA Agreement during the pendency of the Chapter 11 Cases.
On May 3, 1999, the Company elected not to make the interest payment of
approximately $14.8 million due on the $300 million 9 7/8% Guaranteed Senior
Subordinated Notes due 2005 (the "1998 Notes"). The failure to pay interest
resulted in an event of default under the 1998 Notes.
In accordance with SOP 90-7, outstanding borrowings under the Credit
Agreement ($511 million) and the principal amount of the 1998 Notes ($300
million) have been presented as liabilities subject to compromise in the
Company's consolidated balance sheet at December 31, 2000. If the Chapter 11
Cases had not been filed, the Company would have reported a working capital
deficit approximating $942 million at December 31, 2000. The consolidated
financial statements do not include any adjustments that might result from the
resolution of the Chapter 11 Cases or other matters discussed herein. During
the pendency of the Chapter 11 Cases, the Company is continuing to record the
contractual amount of interest expense related to the Credit Agreement. No
interest costs have been recorded related to the 1998 Notes since the filing of
the Chapter 11 Cases. Contractual interest expense for the 1998 Notes not
recorded in the consolidated statement of operations aggregated $30 million in
2000 and $9 million in 1999.
As previously reported, the Company was informed by the United States
Department of Justice (the "DOJ") that the Company and Ventas are the subjects
of ongoing investigations into various Medicare reimbursement issues, including
hospital cost reporting issues, Vencare billing practices and various quality
of care issues in the hospitals and nursing centers formerly operated by Ventas
and currently operated by the Company. In connection with the Amended Plan, the
claims of the DOJ will be settled through a government settlement entered into
with the Company and Ventas (the "Government Settlement"). The Government
Settlement also provides for the dismissal of certain pending claims and
lawsuits filed against the Company. See Note 20.
Agreements with Ventas
On March 18, 1999, the Company served Ventas with a demand for mediation
pursuant to the Agreement and Plan of Reorganization governing the Spin-off
(the "Spin-off Agreement"). The Company was seeking a reduction in rent and
other concessions under its lease agreements with Ventas (the "Master Lease
Agreements"). Shortly thereafter, the Company and Ventas entered into a series
of standstill and tolling agreements which provided that both companies would
postpone any claims either may have against the other and extend any applicable
statutes of limitation.
As a result of the Company's failure to pay rent, Ventas served the Company
with notices of nonpayment under the Master Lease Agreements. Subsequently, the
Company and Ventas entered into further amendments to the second standstill and
the tolling agreements to extend the time during which no remedies may be
pursued by either party and to extend the date by which the Company may cure
its failure to pay rent.
In connection with the Chapter 11 Cases, the Company and Ventas entered into
a stipulation (the "Stipulation") that provides for the payment by the Company
of a reduced aggregate monthly rent of
F-14
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
Agreements with Ventas (Continued)
approximately $15.1 million. The Stipulation has been approved by the
Bankruptcy Court. The difference between the base rent under the Master Lease
Agreements and the reduced aggregate monthly rent is being accrued as an
administrative expense subject to compromise in the Chapter 11 Cases.
The Stipulation also continues to toll any statutes of limitations for claims
that might be asserted by the Company against Ventas and provides that the
Company will continue to fulfill its indemnification obligations arising from
the Spin-off. The Stipulation automatically renews for one-month periods unless
either party provides a 14-day notice of termination. The Stipulation will be
terminated upon the effective date of the Amended Plan. See Note 20.
On May 31, 2000, the Company announced that the Bankruptcy Court had approved
a tax stipulation agreement between the Company and Ventas (the "Tax
Stipulation"). The Tax Stipulation provides that certain refunds of federal,
state and local taxes received by either party on or after September 13, 1999
will be held by the recipient of such refunds in segregated interest bearing
accounts. The Tax Stipulation requires notification before either party can
withdraw funds from the segregated accounts and will terminate upon the
effective date of the Amended Plan.
The Company believes that the Amended Plan, if consummated, will resolve all
material disputes between the Company and Ventas. The Amended Plan also
provides for comprehensive mutual releases between the Company and Ventas,
other than for obligations that the Company is assuming under the Amended Plan.
If the Amended Plan does not become effective and the Company and Ventas are
unable to otherwise resolve their disputes or maintain an interim resolution,
the Company may seek to pursue claims against Ventas arising out of the Spin-
off and seek judicial relief barring Ventas from exercising any remedies based
on the Company's failure to pay some or all of the rent to Ventas. The
Company's failure to pay rent or otherwise comply with the Stipulation, in the
absence of judicial relief, would result in an "Event of Default" under the
Master Lease Agreements. Upon an Event of Default under the Master Lease
Agreements, assuming Ventas were to be granted relief from the automatic stay
by the Bankruptcy Court, the remedies available to Ventas include, without
limitation, terminating the Master Lease Agreements, repossessing and reletting
the leased properties and requiring the Company to (a) remain liable for all
obligations under the Master Lease Agreements, including the difference between
the rent under the Master Lease Agreements and the rent payable as a result of
reletting the leased properties or (b) pay the net present value of the rent
due for the balance of the terms of the Master Lease Agreements. Such remedies,
however, would be subject to the supervision of the Bankruptcy Court.
General
On September 14, 1999, the Company received approval from the Bankruptcy
Court to pay pre-petition and post-petition employee wages, salaries, benefits
and other employee obligations. The Bankruptcy Court also approved orders
granting authority, among other things, to pay pre-petition claims of certain
critical vendors, utilities and patient obligations. All other pre-petition
liabilities are classified in the consolidated balance sheet as liabilities
subject to compromise. The Company currently is paying the post-petition claims
of all vendors and providers in the ordinary course of business.
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
against the Company are subject to an automatic stay and other contractual
obligations against the Company may not be enforced. The automatic
F-15
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (Continued)
General (Continued)
stay does not necessarily apply to certain actions against Ventas for which the
Company has agreed to indemnify Ventas in connection with the Spin-off. In
addition, the Company may assume or reject executory contracts, including lease
obligations, under the Bankruptcy Code. Parties affected by these rejections
may file claims with the Bankruptcy Court in accordance with the reorganization
process.
Liabilities Subject to Compromise
A substantial portion of pre-petition liabilities are subject to settlement
under the Amended Plan. "Liabilities subject to compromise" refers to
liabilities incurred prior to the commencement of the Chapter 11 Cases. These
liabilities, consisting primarily of long-term debt, amounts due to third-party
payors and certain accounts payable and accrued liabilities, represent the
Company's estimate of known or potential claims to be resolved in connection
with the Chapter 11 Cases. Such claims remain subject to future adjustments
based on assertions of additional claims, negotiations, actions of the
Bankruptcy Court, further developments with respect to disputed claims, future
rejection of executory contracts or unexpired leases, determination as to the
value of any collateral securing claims and other events. Proposed payment
terms for these amounts are set forth in the Amended Plan.
All pre-petition liabilities, other than those for which the Company has
received Bankruptcy Court approval to pay, have been classified in the
consolidated balance sheet as liabilities subject to compromise. A summary of
the principal categories of claims classified as liabilities subject to
compromise under the Chapter 11 Cases follows (in thousands):
December 31, December 31,
2000 1999
------------ ------------
Long-term debt:
Credit Agreement................................. $ 510,908 $ 506,114
1998 Notes....................................... 300,000 300,000
Amounts due under the HCFA Agreement............. 63,405 80,296
8 5/8% Senior Subordinated Notes................. 2,391 2,391
Unamortized deferred financing costs............. (10,306) (12,626)
Other............................................ 2,873 4,592
---------- ----------
869,271 880,767
---------- ----------
Due to third-party payors.......................... 116,062 112,694
Accounts payable................................... 36,053 33,693
Income taxes....................................... 13,478 -
Accrued liabilities:
Interest......................................... 90,655 45,521
Ventas rent...................................... 81,902 33,884
Other............................................ 52,952 52,858
---------- ----------
225,509 132,263
---------- ----------
$1,260,373 $1,159,417
========== ==========
Substantially all of the liabilities subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.
F-16
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 4--VENCARE REALIGNMENT
During 1999, the Company operated its Vencare ancillary services business
which provided respiratory and rehabilitation therapies and medical and
pharmacy management services to nursing centers and other healthcare providers.
As a result of significant declines in the demand for ancillary services caused
by the Balanced Budget Act of 1997 (the "Budget Act"), management completed a
realignment of its Vencare division in the fourth quarter of 1999. Vencare's
physical rehabilitation, speech and occupational therapies were integrated into
the Company's nursing center division and the division was renamed the health
services division. Vencare's institutional pharmacy business was assigned to
the hospital division. Vencare's respiratory therapy and other ancillary
businesses have been discontinued.
In connection with the realignment, the Company recorded a charge aggregating
$56.3 million in the fourth quarter of 1999. See Note 6.
NOTE 5--BUSINESS COMBINATIONS
Acquisitions of healthcare facilities (including certain previously leased
facilities) and other related businesses, have been accounted for by the
purchase method. Accordingly, the aggregate purchase price of these
transactions has been allocated to tangible and identifiable intangible assets
acquired and liabilities assumed based upon their respective fair values. The
consolidated financial statements include the operations of acquired entities
since the respective acquisition dates. The pro forma effect of these
acquisitions on the Company's results of operations prior to consummation was
not significant.
The following is a summary of acquisitions consummated during 1998 under the
purchase method of accounting (in thousands):
Fair value of assets acquired....................................... $32,286
Fair value of liabilities assumed................................... (8,059)
-------
Net cash paid for acquisitions.................................... $24,227
=======
The purchase price paid in excess of the fair value of identifiable net
assets of acquired entities aggregated $7.9 million.
NOTE 6--UNUSUAL TRANSACTIONS
Operating results for each of the last three years include certain unusual
transactions. These transactions are included in other operating expenses in
the consolidated statement of operations (unless otherwise indicated) for the
respective periods in which they were recorded.
2000
Operating results for 2000 include a $9.2 million write-off of an impaired
investment recorded in the third quarter and a $4.5 million gain on the sale of
a closed hospital recorded in the second quarter.
F-17
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--UNUSUAL TRANSACTIONS (Continued)
1999
The following table summarizes the pretax impact of unusual transactions
recorded during 1999 (in millions):
Quarters
-------------------------
First Second Third Fourth Year
----- ------ ----- ------ ------
(Income)/expense
Asset valuation losses:
Long-lived asset impairment........... $330.4 $330.4
Investment in BHC..................... $15.2 15.2
Cancellation of software development
project................................ 5.6 5.6
Realignment of Vencare division......... 56.3 56.3
Retirement plan curtailment............. 7.3 7.3
Corporate properties.................... (2.4) (2.4)
--- ----- --- ------ ------
$ - $20.8 $ - $391.6 $412.4
=== ===== === ====== ======
Long-lived asset impairment--SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"),
requires impairment losses to be recognized for long-lived assets used in
operations when indications of impairment are present and the estimate of
undiscounted future cash flows is not sufficient to recover asset carrying
amounts. SFAS 121 also requires that long-lived assets held for disposal be
carried at the lower of carrying value or fair value less costs of disposal,
once management has committed to a plan of disposal.
Operating results and related cash flows for 1999 did not meet management's
expectations. These expectations were the basis upon which the Company valued
its long-lived assets at December 31, 1998, in accordance with SFAS 121. In
addition, certain events occurred in 1999 which had a negative impact on the
Company's operating results and are expected to impact negatively its
operations in the future. In connection with the negotiation of the Government
Settlement, the Company agreed to exclude certain expenses from its hospital
Medicare cost reports beginning September 1, 1999 for which the Company had
been reimbursed in prior years. Medicare revenues related to the reimbursement
of such costs aggregated $18 million in 1999 and $47 million in 1998. In
addition, hospital revenues in 1999 were reduced by approximately $19 million
as a result of disputes with certain insurers who issued Medicare supplement
insurance policies to individuals who became patients of the Company's
hospitals. The Company also reviewed the expected impact of the Balanced Budget
Refinement Act (the "BBRA") enacted in November 1999 (which provided a measure
of relief for some impact of the Budget Act) and the realignment of the Vencare
ancillary services business completed in the fourth quarter of 1999. The actual
and expected future impact of these issues served as an indication to
management that the carrying values of the Company's long-lived assets may be
impaired.
In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and compared these estimates to the
carrying values of the underlying assets. As a result of these estimates, the
Company reduced the carrying amounts of the assets associated with 71 nursing
centers and 21 hospitals to their respective estimated fair values. The
determination of the fair values of the impaired facilities was based upon the
net present value of estimated future cash flows.
F-18
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--UNUSUAL TRANSACTIONS (Continued)
A summary of the impairment charges follows (in millions):
Property and
Goodwill Equipment Total
-------- ------------ ------
Health services division....................... $ 18.3 $ 37.7 $ 56.0
Hospital division.............................. 198.9 75.5 274.4
------- ------ ------
$ 217.2 $113.2 $330.4
======= ====== ======
Investment in BHC--In connection with the acquisition of Transitional
Hospitals Corporation ("Transitional") in 1997, the Company acquired a 44%
voting equity interest (61% equity interest) in Behavioral Healthcare
Corporation ("BHC"), an operator of psychiatric and behavioral clinics. In the
second quarter of 1999, the Company wrote off its remaining investment in BHC
aggregating $15.2 million as a result of deteriorating financial performance.
See the discussion of unusual transactions recorded in 1998 for further
information related to the Company's investment in BHC.
Cancellation of software development project--In the second quarter of 1999,
the Company canceled a nursing center software development project and charged
previously capitalized costs to operations.
Realignment of Vencare division--As discussed in Note 4, the Company
realigned the Vencare ancillary services division in the fourth quarter of
1999. As a result, the Company recorded a charge aggregating $56.3 million,
including the write-off of goodwill totaling $42.3 million. The remainder of
the charge related to the write-down of certain equipment to net realizable
value and the recording of employee severance costs.
Retirement plan curtailment--In December 1999, the Board of Directors
approved the curtailment of benefits under the Company's supplemental executive
retirement plan, resulting in an actuarially determined charge of $7.3 million.
Under the terms of the curtailment, plan benefits were vested for each eligible
participant through December 31, 1999 and the accrual of future benefits under
the plan was substantially eliminated. The Board of Directors also deferred the
time at which certain benefits would be paid by the Company.
Corporate properties--During 1999, the Company adjusted estimated property
loss provisions recorded in the fourth quarter of 1998, resulting in a pretax
credit of $2.4 million.
F-19
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--UNUSUAL TRANSACTIONS (Continued)
1998
The following table summarizes the pretax impact of unusual transactions
recorded during 1998 (in millions):
Quarters
----------------------------
First Second Third Fourth Year
----- ------ ------- ------ --------
(Income)/expense
Asset valuation losses:
Long-lived asset impairment...... $307.8 $ 307.8
Investment in BHC................ $ 8.5 43.1 51.6
Wisconsin nursing center......... 27.5 27.5
Corporate properties............. $ 8.8 2.9 15.1 26.8
Acquired entities................ 13.5 13.5
Gain on sale of investments........ (98.5) (13.0) (111.5)
Losses from termination of
construction projects............. 71.3 71.3
Spin-off transaction costs......... $7.7 9.6 17.3
Write-off of clinical information
systems........................... 10.1 10.1
Doubtful accounts related to sold
operations........................ 9.6 9.6
Settlement of litigation........... 7.8 7.8
Loss on sale and closure of home
health and hospice businesses..... 7.3 7.3
---- ----- ------- ------ --------
$7.7 $25.7 $ (6.2) $411.9 $ 439.1
==== ===== ======= ====== ========
Long-lived asset impairment--The Budget Act established, among other things,
a new Medicare prospective payment system ("PPS") for nursing centers. All of
the Company's nursing centers became subject to PPS effective July 1, 1998.
During the first three years, the per diem rates for nursing centers are based
on a blend of facility-specific and federal costs. Thereafter, the per diem
rates will be based solely on federal costs. The revenues recorded under PPS in
the Company's health services division were substantially less than the cost-
based reimbursement it received before the enactment of the Budget Act.
The Budget Act also reduced payments to the Company's hospitals by reducing
incentive payments pursuant to the Tax Equity and Fiscal Responsibility Act of
1982 ("TEFRA"), allowable costs for capital expenditures and bad debts, and
payments for services to patients transferred from a general acute care
hospital. The reductions in allowable costs for capital expenditures became
effective in the fourth quarter of 1997. The reductions in TEFRA incentive
payments and allowable costs for bad debts became effective in the third and
fourth quarters of 1998. The reduction for payments for services to patients
transferred from a general acute care hospital became effective in the fourth
quarter of 1998. These reductions had a material adverse impact on hospital
revenues in 1998.
The Company provides ancillary services to both Company-operated and non-
affiliated nursing centers. While most of the nursing center industry became
subject to PPS on or after January 1, 1999, management believed that Vencare's
ability to maintain services and revenues was impacted adversely during 1998,
particularly in the third and fourth quarters, since nursing centers were
reluctant to enter into ancillary service contracts while transitioning to the
new fixed payment system under PPS. Medicare reimbursements to nursing centers
under PPS include substantially all services provided to patients, including
ancillary services. Management believes that the decline in demand for its
Vencare services in 1998, particularly respiratory
F-20
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--UNUSUAL TRANSACTIONS (Continued)
therapy and rehabilitation therapy, was mostly attributable to efforts by
nursing center customers to reduce operating costs. In addition, as a result of
these regulatory changes, many nursing centers began providing ancillary
services to their patients through internal staff and no longer contracted with
outside parties for ancillary services.
In January 1998, HCFA issued rules changing Medicare reimbursement guidelines
for therapy services provided by the Company. Under these rules, HCFA
established salary equivalency limits for speech and occupational therapy
services and revised limits for physical and respiratory therapy services. The
new limits became effective for services provided on or after April 10, 1998
and negatively impacted operating results of the Company's ancillary services
businesses in 1998.
These significant regulatory changes and the impact of such changes on the
Company's operating results in the third and fourth quarters of 1998 served as
an indication to management that the carrying values of the assets of its
nursing center and hospital facilities, as well as certain portions of its
ancillary services business, may be impaired.
In accordance with SFAS 121, management estimated the future undiscounted
cash flows for each of its facilities and ancillary services lines of business
and compared these estimates to the carrying values of the underlying assets.
As a result of these estimates, the Company reduced the carrying amounts of the
assets associated with 110 nursing centers, 12 hospitals and a portion of the
goodwill associated with its rehabilitation therapy business to their
respective estimated fair values. The determination of the fair values of the
impaired facilities and rehabilitation therapy business was based upon the net
present value of estimated future cash flows.
A summary of the impairment charges follows (in millions):
Property and
Goodwill Equipment Total
-------- ------------ ------
Health services division:
Nursing centers.............................. $ 27.7 $ 71.6 $ 99.3
Ancillary services........................... 99.2 0.2 99.4
Hospital division.............................. 74.4 34.7 109.1
------ ------ ------
$201.3 $106.5 $307.8
====== ====== ======
In addition to the above impairment charges, the amortization period for the
remaining goodwill associated with the Company's rehabilitation therapy
business was reduced from forty years to seven years, effective October 1,
1998. Management believed that the provisions of the Budget Act altered the
expected long-term cash flows and business prospects associated with this
business to such an extent that a shorter amortization period was deemed
appropriate. The change in the amortization period resulted in an additional
pretax charge to operations of $6.4 million in the fourth quarter of 1998. In
the fourth quarter of 1999, in connection with the realignment of Vencare, the
Company wrote off all of the goodwill associated with the rehabilitation
therapy business.
Investment in BHC--Subsequent to the Transitional merger, the Company had
been unsuccessful in its attempts to sell its investment in BHC. In July 1998,
the Company entered into an agreement to sell its interest in BHC for an amount
less than its carrying value and accordingly, a provision for loss of $8.5
million was recorded during the third quarter. In November 1998, the agreement
to sell the Company's interest in BHC was
F-21
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--UNUSUAL TRANSACTIONS (Continued)
terminated by the prospective buyer, indicating to the Company that the
carrying amount of its investment may be impaired. Following an independent
appraisal, the Company recorded a $43.1 million write-down of the investment in
the fourth quarter of 1998. The net carrying amount of the investment
aggregated $20.0 million at December 31, 1998.
Wisconsin nursing center--The Company recorded an asset impairment charge of
$27.5 million in the fourth quarter of 1998 related to a nursing center in
Wisconsin that is leased from Ventas. The impairment resulted primarily from
certain fourth quarter regulatory actions by state and federal agencies with
respect to the operation of the facility. In the fourth quarter of 1998, the
facility reported a pretax loss of $4.2 million and is not expected to generate
positive cash flows in the future.
Corporate properties and acquired entities--During 1998, the Company recorded
$26.8 million of charges related to the valuation of certain corporate assets,
the most significant of which relates to previously capitalized amounts and
expected property disposal losses associated with the cancellation of a
corporate headquarters construction project. The Company also recorded $13.5
million of asset write-downs associated with the acquisition of The Hillhaven
Corporation ("Hillhaven"), TheraTx, Incorporated ("TheraTx") and Transitional,
including provisions for obsolete or abandoned computer equipment and
miscellaneous receivables.
Gain on sale of investments--In September 1998, the Company sold its
investment in its assisted living affiliate, Atria Communities, Inc. ("Atria")
for $177.5 million in cash and an equity interest in the surviving corporation,
resulting in a gain of $98.5 million. In November 1998, the Company's
investment in Colorado MEDtech, Inc. was sold at a gain of $13.0 million.
Proceeds from the sale were $22.0 million.
Losses from termination of construction projects--In the third quarter of
1998, as a result of substantial reductions in Medicare reimbursement to the
Company's nursing centers and hospitals in connection with the Budget Act,
management determined to suspend all acquisition and development activities,
terminate the construction of substantially all of its development properties,
and close two recently acquired hospitals. Accordingly, the Company recorded
pretax charges aggregating $71.3 million, of which $53.9 million related to the
cancellation of construction projects and the remainder related to the planned
closure of the hospitals. In connection with the construction termination
charge, the Company decided that it would not replace certain facilities that
previously were accounted for as assets intended for disposal. Accordingly, the
$53.9 million charge discussed above included a $10.0 million reversal of a
previously recorded valuation allowance (the amount necessary to reduce the
carrying value to fair value less costs of disposal) related to such
facilities.
Spin-off transaction costs--The Spin-off was completed on May 1, 1998. Direct
costs related to the transaction totaled $17.3 million and primarily included
costs for professional services.
Write-off of clinical information systems--During 1997, the Company began the
installation of its proprietary clinical information system, VenTouch(TM), in
several of its nursing centers. During the pilot process, the Company
determined that VenTouch(TM) did not support effectively the nursing center
processes, especially in facilities with lower acuity patients. Accordingly,
management determined in the fourth quarter of 1998 to remove VenTouch(TM) from
these facilities during 1999. A loss of $10.1 million was recorded to reflect
the write-off of the equipment and estimated costs of removal from the
facilities.
Doubtful accounts related to sold operations--In the third quarter of 1998,
the Company recorded $9.6 million of additional provisions for doubtful
accounts for accounts receivable associated with previously sold facilities.
F-22
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6--UNUSUAL TRANSACTIONS (Continued)
Settlement of litigation--The Company settled a legal action entitled
Highland Pines Nursing Center, Inc., et al. v. TheraTx, Incorporated, et al.
(assumed in connection with the TheraTx merger) which resulted in a payment of
$16.2 million. Approximately $7.8 million of the settlement was charged to
earnings in the fourth quarter of 1998, and the remainder of such costs had
been previously accrued in connection with the purchase price allocation.
Loss on sale and closure of home health and hospice businesses--The Company
began operating its home health and hospice businesses in 1996. These
operations generally were unprofitable. In the second quarter of 1998,
management decided to cease operations and either close or sell these
businesses, resulting in a loss of $7.3 million.
NOTE 7--FOURTH QUARTER ADJUSTMENTS
In addition to the unusual transactions discussed in Note 6, during the
fourth quarter of 1999 and 1998, the Company recorded certain adjustments which
significantly impacted operating results. A summary of such adjustments follows
(in millions):
(Restated)
-----------------------------------------------------
Health Services
Division Hospital Division
----------------- ------------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- ------
1999
(Income)/expense
Provision for doubtful
accounts............... $40.2 $26.8 $ 6.5 $ 8.9 $ 82.4
Medicare supplement
insurance disputes..... 18.8 18.8
Third-party
reimbursements and
contractual allowances,
including amounts due
from government
agencies and other
payors that are subject
to dispute............. 2.0 59.6 61.6
Professional liability
risks.................. 14.7 0.4 1.8 0.1 17.0
Employee benefits....... (6.3) (1.5) (1.8) (9.6)
Incentive compensation.. 2.2 (1.9) (1.1) (0.8)
Inventories............. 0.9 6.3 7.2
Other................... 1.7 (0.4) 2.0 (4.4) $(2.8) (3.9)
----- ----- ----- ----- ----- ------
$55.4 $25.3 $85.0 $ 9.8 $(2.8) $172.7
===== ===== ===== ===== ===== ======
F-23
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 7--FOURTH QUARTER ADJUSTMENTS (Continued)
(Restated)
-----------------------------------------------------
Health Services
Division Hospital Division
------------------ ------------------
Nursing Ancillary
Centers Services Hospitals Pharmacy Corporate Total
------- --------- --------- -------- --------- -----
1998
(Income)/expense
Provision for doubtful
accounts............... $ 14.0 $ 6.8 $ 5.7 $2.5 $29.0
Third-party
reimbursements and
contractual allowances,
including amounts due
from government
agencies and other
payors that are subject
to dispute............. 4.8 11.5 11.4 27.7
Change in goodwill
amortization period
related to
rehabilitation therapy
business............... 6.4 6.4
Taxes other than
income................. $ 6.4 6.4
Professional liability
risks.................. 3.5 0.2 1.8 5.5
Compensated absences.... 2.1 1.3 (0.8) 0.7 3.3
Incentive compensation.. (1.0) (0.4) (0.8) (0.1) (2.9) (5.2)
Litigation and
regulatory actions..... 3.5 3.5
Miscellaneous
receivables............ 5.2 5.2
Gain on sale of assets.. (2.0) (2.0)
Other................... 1.2 0.4 (1.0) 0.3 3.7 4.6
------ ----- ----- ---- ----- -----
$ 24.6 $24.2 $16.3 $7.9 $11.4 $84.4
====== ===== ===== ==== ===== =====
The Company regularly reviews its accounts receivable and records provisions
for loss based upon the best available evidence. Factors such as changes in
collection patterns, the composition of patient accounts by payor type, the
status of ongoing disputes with third-party payors (including both government
and non-government sources), the effect of increased regulatory activities,
general industry conditions and the financial condition of the Company and its
ancillary service customers, among other things, are considered by management
in determining the expected collectibility of accounts receivable.
During 1999 and 1998, the Company recorded significant adjustments in the
fourth quarter related to contractual allowances and doubtful accounts in each
of its divisions. These adjustments represented changes in estimates resulting
from management's assessment of its collection processes, the general financial
deterioration of the long-term healthcare industry and, in 1999, the
realignment of the Vencare businesses (including the cancellation of
unprofitable contracts and the discontinuance of certain services) and the
filing of the Chapter 11 Cases in September 1999.
In addition, the Company recorded a significant adjustment in the fourth
quarter of 1999 related to professional liability risks. This adjustment was
recorded based upon actuarially determined estimates completed in the fourth
quarter and reflects substantial increases in claims and litigation activity in
the Company's nursing center business during 1999.
F-24
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 8--BUSINESS SEGMENT DATA
The Company operates two business segments: the health services division and
the hospital division. The health services division operates nursing centers
and a rehabilitation therapy business. The hospital division operates hospitals
and an institutional pharmacy business.
The following table represents the Company's revenues, operating results,
capital expenditures and assets by operating segment and gives effect to the
realignment of the former Vencare businesses for all periods presented. The
Company defines operating income as earnings before interest, income taxes,
depreciation, amortization and rent. Operating income reported for each of the
Company's business segments excludes allocations of corporate overhead.
2000 1999 1998
---------- ---------- ----------
(In thousands)
Revenues:
Health services division:
Nursing centers........................... $1,675,627 $1,594,244 $1,667,343
Rehabilitation services................... 135,036 195,731 264,574
Other ancillary services.................. - 43,527 168,165
Elimination............................... (77,191) (128,267) (124,500)
---------- ---------- ----------
1,733,472 1,705,235 1,975,582
Hospital division:
Hospitals................................. 1,007,947 850,548 919,847
Pharmacy.................................. 204,252 171,493 149,991
---------- ---------- ----------
1,212,199 1,022,041 1,069,838
---------- ---------- ----------
2,945,671 2,727,276 3,045,420
Elimination of pharmacy charges to Company
nursing centers.......................... (57,129) (61,635) (45,681)
---------- ---------- ----------
$2,888,542 $2,665,641 $2,999,739
========== ========== ==========
Income (loss) from operations (restated):
Operating income (loss):
Health services division:
Nursing centers.......................... $ 278,738 $ 169,128 $ 213,036
Rehabilitation services.................. 8,047 2,891 18,398
Other ancillary services................. 4,737 4,166 30,183
---------- ---------- ----------
291,522 176,185 261,617
Hospital division:
Hospitals................................ 205,858 132,050 247,272
Pharmacy................................. 7,421 342 15,301
---------- ---------- ----------
213,279 132,392 262,573
Corporate overhead........................ (113,823) (108,947) (126,291)
Unusual transactions...................... (4,701) (412,418) (439,125)
Reorganization costs...................... (12,636) (18,606) -
---------- ---------- ----------
Operating income (loss).................. 373,641 (231,394) (41,226)
Rent....................................... (307,809) (305,120) (234,144)
Depreciation and amortization.............. (73,545) (93,196) (124,617)
Interest, net.............................. (55,038) (75,254) (102,320)
---------- ---------- ----------
Loss before income taxes................... (62,751) (704,964) (502,307)
Provision for income taxes................. 2,000 500 76,099
---------- ---------- ----------
$ (64,751) $ (705,464) $ (578,406)
========== ========== ==========
Capital expenditures:
Health services division.................. $ 28,451 $ 42,144 $ 126,880
Hospital division......................... 23,675 23,918 55,789
Corporate:
Information systems...................... 25,475 40,777 47,541
Other.................................... 2,387 4,654 37,078
---------- ---------- ----------
$ 79,988 $ 111,493 $ 267,288
========== ========== ==========
Assets at end of period:
Health services division.................. $ 494,636 $ 489,316
Hospital division......................... 354,302 337,218
Corporate................................. 485,476 409,440
---------- ----------
$1,334,414 $1,235,974
========== ==========
F-25
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 9--INCOME TAXES
Provision for income taxes consists of the following (in thousands):
2000 1999 1998
------ ---- ----------
(Restated)
Current:
Federal............................................. $ - $ - $ 2,131
State............................................... 2,000 500 355
------ ---- -------
2,000 500 2,486
Deferred.............................................. - - 73,613
------ ---- -------
$2,000 $500 $76,099
====== ==== =======
Reconciliation of federal statutory tax expense to the provision for income
taxes follows (in thousands):
(Restated)
------------------------------
2000 1999 1998
-------- --------- ---------
Income tax benefit at federal rate......... $(21,963) $(249,861) $(175,807)
State income tax benefit, net of federal
income tax benefit........................ (2,197) (24,985) (17,581)
Merger related costs....................... - - 5,943
Goodwill amortization...................... 3,997 8,541 8,823
Write-off of goodwill...................... - 99,902 77,482
Gain on sale of Atria...................... - - (37,908)
Acquisition costs and merger adjustments... - - 8,851
Valuation allowance........................ 12,222 154,933 205,066
Reorganization costs....................... 7,372 4,672 -
Other items, net........................... 2,569 7,298 1,230
-------- --------- ---------
$ 2,000 $ 500 $ 76,099
======== ========= =========
A summary of deferred income taxes by source included in the consolidated
balance sheet at December 31 follows (in thousands):
2000 1999
----------------------- -----------------------
Assets Liabilities Assets Liabilities
---------- ----------- ---------- -----------
(Restated) (Restated)
Depreciation............... $ - $28,047 $ - $11,275
Insurance.................. 33,747 - 21,335 -
Doubtful accounts.......... 140,526 - 143,193 -
Property................... 102,865 - 105,555 -
Compensation............... 21,785 - 16,234 -
Subsidiary net operating
losses (expiring in
2020)..................... 79,915 - 56,087 -
Other...................... 47,484 26,054 47,086 18,216
--------- ------- --------- -------
426,322 $54,101 389,490 $29,491
======= =======
Reclassification of
deferred tax liabilities.. (54,101) (29,491)
--------- ---------
Net deferred tax assets.... 372,221 359,999
Valuation allowance........ (372,221) (359,999)
--------- ---------
$ - $ -
========= =========
F-26
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 9--INCOME TAXES (Continued)
Prior to 1998, management believed that recorded deferred tax assets
ultimately would be realized. Management's conclusions at that time were based
primarily on the existence of sufficient taxable income within the allowable
carryback periods to realize the tax benefits of deductible temporary
differences recorded at December 31, 1997. For the fourth quarter of 1998, the
Company reported a pretax loss of $512 million. Additionally, the Company
revised its operating budgets as a result of the Budget Act and the less than
expected operating results in 1998. Based upon those revised forecasts,
management did not believe that the Company could generate sufficient taxable
income to realize the net deferred tax assets recorded at December 31, 1998.
Accordingly, the Company recorded a deferred tax asset valuation allowance
aggregating $205 million in the fourth quarter of 1998. Deferred tax valuation
allowances recorded in 1999 and 2000 totaled $155 million and $12 million,
respectively. The deferred tax valuation allowance included in the consolidated
balance sheet at December 31, 2000 totaled $372 million.
At the time of the Spin-off, the Company recorded both a deferred tax asset
and a valuation allowance for identical amounts in connection with the
difference in book and tax basis of the Company's investment in Atria which
resulted from the Spin-off. The valuation allowance was recorded due to the
litigation and other uncertainties associated with the realization of the
deferred tax asset, based upon the available evidence at the time of the Spin-
off. During the third quarter of 1998, upon favorable resolution of such
litigation and completion of the Atria sale, the Company adjusted the valuation
allowance that had been recorded in the second quarter of 1998.
NOTE 10--PROFESSIONAL LIABILITY RISKS
The Company insures a substantial portion of its professional and general
liability risks primarily through a wholly owned insurance subsidiary.
Provisions for such risks were $47.2 million for 2000, $61.3 million for 1999
and $22.2 million for 1998.
The allowance for professional liability risks aggregated $119.1 million and
$95.4 million at December 31, 2000 and 1999, respectively, including $17.9
million and $22.6 million, respectively, classified as a current liability. The
Company also maintains reinsurance contracts with an unrelated insurer.
Reinsurance recoverables related to these risks (included in accounts
receivable and noncurrent assets) aggregated $21.7 million and $34.8 million at
December 31, 2000 and 1999, respectively.
At December 31, 2000 and 1999, investments held for the payment of claims and
expenses related to self-insured risks aggregated $64.6 million and $18.8
million, respectively, including $2.1 million and $2.3 million, respectively,
classified as a noncurrent asset.
F-27
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 11--LONG-TERM DEBT
Capitalization
All long-term debt has been classified as liabilities subject to compromise.
A summary of long-term debt at December 31 follows (in thousands):
2000 1999
--------- ---------
Senior collateralized debt, 8% to 8.75% (rates
generally floating) payable in periodic installments
through 2017........................................ $ 1,746 $ 1,851
Term A Loan, 7.9% to 8.6% (rates generally floating)
payable in periodic installments through 2003....... 224,623 224,623
Term B Loan, 8.4% to 9.1% (rates generally floating)
payable in periodic installments through 2005....... 226,491 226,491
Bank revolving credit agreement due 2003 (floating
rates averaging 10%)................................ 59,794 55,000
9 7/8% Guaranteed Senior Subordinated Notes due
2005................................................ 300,000 300,000
8 5/8% Senior Subordinated Notes due 2007............ 2,391 2,391
Amounts due to HCFA, 13.4% payable in monthly
installments through 2004........................... 63,405 80,296
Unamortized deferred financing costs................. (10,306) (12,626)
Other................................................ 1,127 2,741
--------- ---------
Total debt, average life of four years (rates
averaging 9.5%)................................... 869,271 880,767
Amounts subject to compromise........................ (869,271) (880,767)
--------- ---------
Long-term debt..................................... $ - $ -
========= =========
In accordance with SOP 90-7, unamortized deferred financing costs have been
classified as reductions of long-term debt subject to compromise.
In connection with the Chapter 11 Cases, the Company entered into the DIP
Financing with the DIP Lenders. At December 31, 2000, the Company was in
compliance with the terms of the DIP Financing.
In connection with the Spin-off, the Company consummated the $1.0 billion
Credit Agreement which includes: (a) a five-year $300 million revolving credit
facility (the "Revolving Credit Facility"), (b) a $250 million Term A Loan (the
"Term A Loan") payable in various installments over five years, (c) a
$250 million Term B Loan (the "Term B Loan") payable in installments of 1% per
year with the outstanding balance due in seven years and (d) a $200 million
Bridge Loan (the "Bridge Loan") which was repaid in September 1998 primarily
from the proceeds of the sale of the Company's investment in Atria. Interest is
payable, depending on certain leverage ratios and other factors, at a rate of
prime plus 2% to 3 1/2% for the Revolving Credit Facility, LIBOR plus 3/4% to
3% for the Term A Loan, and LIBOR plus 2 1/4% to 3 1/2% for the Term B Loan.
On April 30, 1998, the Company completed the private placement of $300
million aggregate principal amount of the 1998 Notes, which are not callable by
the Company until 2002. On September 10, 1998, the Company exchanged the 1998
Notes for publicly registered securities having identical terms and conditions.
Approximately $831 million of debt subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.
Refinancing Activities
In connection with the Spin-off, the Company refinanced substantially all of
its long-term debt, resulting in after-tax losses of $78 million in 1998.
F-28
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 11--LONG-TERM DEBT (Continued)
Other Information
At December 31, 1999, the Company was a party to certain interest rate swap
agreements that eliminated the impact of changes in interest rates on $100
million of floating rate debt outstanding. The agreements provided for fixed
rates on $100 million of floating rate debt at 6.4% plus 3/8% to 1 1/8% and
expired in May 2000. The fair value of the swap agreements, or the estimated
amount the Company would have paid to terminate the agreements based on current
interest rates, was not recognized in the consolidated financial statements.
The Company was not a party to any interest rate swap agreements at December
31, 2000.
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
against the Company are subject to an automatic stay and other contractual
obligations against the Company may not be enforced. In addition, the Company
may assume or reject executory contracts under the Bankruptcy Code.
If the Chapter 11 Cases had not been filed, the scheduled maturities of long-
term debt in years 2002 through 2005 would be $148 million, $118 million, $183
million and $342 million, respectively.
The estimated fair value of the Company's long-term debt was $537 million and
$485 million at December 31, 2000 and 1999, respectively, compared to carrying
amounts aggregating $880 million and $893 million. The estimate of fair value
at December 31, 1999 includes the effect of the interest rate swap agreements
and is based upon the quoted market prices for the same or similar issues of
long-term debt, or on rates available to the Company for debt of the same
remaining maturities. The estimated fair value of the interest rate swap
agreements was $157,000 (payable position) at December 31, 1999.
NOTE 12--LEASES
The Company leases real estate and equipment under cancelable and non-
cancelable arrangements. The Company may assume or reject executory contracts,
including lease agreements, under the Bankruptcy Code. The Company has not
rejected any lease agreements since the Chapter 11 Cases were filed. Future
minimum payments and related sublease income under non-cancelable operating
leases are as follows (in thousands):
Minimum Payments
----------------------------- Sublease
Ventas Other Total Income
---------- ------- ---------- --------
(Restated)
2001................................ $ 231,135 $46,823 $ 277,958 $4,343
2002................................ 231,135 31,537 262,672 2,514
2003................................ 231,135 23,762 254,897 2,157
2004................................ 231,135 13,950 245,085 1,571
2005................................ 231,135 12,420 243,555 1,571
Thereafter.......................... 1,034,673 58,058 1,092,731 7,092
Sublease income aggregated $2.4 million, $2.4 million and $6.9 million for
2000, 1999 and 1998, respectively.
NOTE 13--CONTINGENCIES
Management continually evaluates contingencies based upon the best available
evidence. In addition, allowances for loss are provided currently for disputed
items that have continuing significance, such as certain third-party
reimbursements and deductions that continue to be claimed in current cost
reports and tax returns.
F-29
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 13--CONTINGENCIES (Continued)
Management believes that allowances for losses have been provided to the
extent necessary and that its assessment of contingencies is reasonable.
Principal contingencies are described below:
Revenues--Certain third-party payments are subject to examination by
agencies administering the programs. The Company is contesting certain
issues raised in audits of prior year cost reports.
Professional liability risks--The Company has provided for loss for
professional liability risks based upon actuarially determined estimates.
Actual settlements may differ from the provisions for loss.
Guarantees of indebtedness--Letters of credit and guarantees of
indebtedness aggregated $3.3 million at December 31, 2000.
Income taxes--The Company is contesting adjustments proposed by the
Internal Revenue Service for years 1995 through 1997. In addition, the
Company claims that it is entitled to certain prior year tax refunds
currently held by Ventas.
Litigation--The Company is a party to certain material litigation and
regulatory actions as well as various suits and claims arising in the
ordinary course of business. See Note 20.
NOTE 14--CAPITAL STOCK
Plan Descriptions
The Company has plans under which options to purchase common stock may be
granted to officers, employees and certain non-employee directors. Options have
been granted at not less than market price on the date of grant. Exercise
provisions vary, but most options are exercisable in whole or in part beginning
one to four years after grant and ending ten years after grant. Activity in the
plans is summarized below:
Shares Weighted
under Option Price Average
Option per Share Exercise Price
---------- --------------- --------------
Balances, December 31, 1997..... 4,395,170 $0.20 to $43.88 $26.77
Granted....................... 6,422,132 3.81 to 10.98 7.00
Exchange offer:
Canceled..................... (5,721,027) 6.12 to 16.87 10.14
Issued....................... 4,631,694 5.50 5.50
Exercised..................... (48,431) 0.12 to 10.96 2.69
Canceled or expired........... (855,904) 3.67 to 16.58 8.22
----------
Balances, December 31, 1998..... 8,823,634 0.08 to 16.58 5.72
Granted....................... 423,000 0.63 to 4.50 2.50
Exercised..................... (7,031) 0.34 0.34
Canceled or expired........... (1,196,924) 0.34 to 16.58 6.19
----------
Balances, December 31, 1999..... 8,042,679 0.08 to 15.09 5.50
Canceled or expired........... (1,813,066) 0.39 to 14.93 6.98
----------
Balances, December 31, 2000..... 6,229,613 $0.08 to $15.09 $ 5.07
==========
F-30
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 14--CAPITAL STOCK (Continued)
Plan Descriptions (Continued)
A summary of stock options outstanding at December 31, 2000 follows:
Options Outstanding Options Exercisable
-------------------------------------- ------------------------
Number Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of at December 31, Contractual Exercise at December 31, Exercise
Exercise Prices 2000 Life Price 2000 Price
--------------- --------------- ------------- -------- --------------- --------
$0.08 to $10.72......... 296,414 1 to 4 years $5.81 296,414 $5.81
$5.50 to $15.09......... 3,280,849 5 to 7 years 5.76 2,935,149 5.72
$0.63 to $5.50.......... 2,652,350 8 to 10 years 4.14 1,659,800 4.32
--------- ---------
6,229,613 $5.07 4,891,363 $5.25
========= =========
The weighted average remaining contractual life of options outstanding at
December 31, 2000 approximated seven years. Shares of common stock available
for future grants were 6,001,333, 3,824,628 and 2,670,846 at December 31, 2000,
1999 and 1998, respectively. The number of options exercisable at December 31,
1999 and December 31, 1998 was 5,347,955 and 1,321,370, respectively.
In connection with the Spin-off, options outstanding prior thereto were
bifurcated on a one-for-one basis between the Company and Ventas, and
corresponding option prices were adjusted in proportion to the fair values of
the respective common stocks immediately following the Spin-off. Option data
for periods prior to the Spin-off have not been restated.
On December 19, 1998, the Company completed the exchange of employee stock
options. The exchange offer entitled employees to exchange outstanding stock
options for a reduced number of options with an exercise price equal to the
closing price of the Company's common stock on November 9, 1998. Exchange
ratios were calculated using a Black-Scholes option valuation model. The
exchange resulted in the cancellation of options to purchase approximately 5.7
million shares and the issuance of options to purchase approximately 4.6
million shares.
In connection with the Spin-off, the Company adopted an employee incentive
compensation and a stock option plan for non-employee directors. These plans
replaced similar plans in effect prior to the Spin-off.
Statement No. 123 Data
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), requires use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options is equal to the market price of the underlying stock on
the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required
by SFAS 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted subsequent to
December 31, 1994 under the fair value method of SFAS 123. The fair value of
such options was estimated at the date of grant using a Black-Scholes option
valuation model with the following weighted average assumptions: risk-free
interest rate of 5.90% for 2000, 5.30% for 1999 and 4.96% for 1998; no dividend
yield; expected term of seven years and volatility factors of the expected
market price of the Company's common stock of .85 for 2000, .82 for 1999 and
.42 for 1998.
F-31
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 14--CAPITAL STOCK (Continued)
Statement No. 123 Data (Continued)
A Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because the changes in the
subjective input assumptions can affect materially the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the respective vesting period. The
weighted average fair values of options granted during 1999 and 1998 under a
Black-Scholes valuation model were $1.92 and $2.62, respectively. There were no
options granted during 2000. Pro forma information follows (in thousands except
per share amounts):
2000 1999 1998
-------- --------- ---------
Pro forma loss available to common
stockholders........................... $(71,296) $(725,319) $(663,440)
Pro forma loss per common share:
Basic................................. $ (1.02) $ (10.30) $ (9.71)
Diluted............................... $ (1.02) $ (10.30) $ (9.71)
NOTE 15--EMPLOYEE BENEFIT PLANS
The Company maintains defined contribution retirement plans covering
employees who meet certain minimum eligibility requirements. Benefits are
determined as a percentage of a participant's contributions and generally are
vested based upon length of service. Retirement plan expense was $8.8 million
for 2000, $10.8 million for 1999 and $12.7 million for 1998. Amounts equal to
retirement plan expense are funded annually.
The Company also established a supplemental executive retirement plan in 1998
covering certain officers under which benefits are determined based primarily
upon participants' compensation and length of service to the Company. The cost
of the plan aggregated $300,000 for 2000 and $11.0 million for 1999. In January
1999, the Company funded $3.7 million of plan obligations to participants
through the purchase of annuities. As discussed in Note 6, the plan was
curtailed by the Board of Directors in December 1999.
NOTE 16--ACCRUED LIABILITIES
A summary of other accrued liabilities at December 31 follows (in thousands):
2000 1999
------- -------
Patient accounts.......................................... $24,490 $23,893
Professional liability risks.............................. 17,888 22,632
Taxes other than income................................... 16,723 11,353
Other..................................................... 24,701 26,089
------- -------
$83,802 $83,967
======= =======
F-32
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 17--TRANSACTIONS WITH VENTAS
For the purpose of governing certain of the ongoing relationships between the
Company and Ventas after the Spin-off and to provide mechanisms for an orderly
transition, the Company and Ventas entered into various agreements. The most
significant agreements are as follows:
Master Lease Agreements
Ventas retained substantially all of the real property, buildings and other
improvements (primarily nursing centers and long-term acute care hospitals) in
the Spin-off and leases them to the Company under four master lease agreements
which set forth the material terms governing the lease of each of the leased
properties. In August 1998, the Company and Ventas entered into a fifth lease
agreement with respect to a nursing center in Corydon, Indiana (the "Corydon
Lease"). The provisions of the Corydon Lease, except for the provisions
relating to rental amounts and the termination date, are substantially similar
to the terms of the other master lease agreements with Ventas. The four master
lease agreements, as amended, and the Corydon Lease shall be referred to herein
collectively as the "Master Lease Agreements" and each, a "Master Lease
Agreement."
Each Master Lease Agreement includes land, buildings, structures and other
improvements on the land, easements and similar appurtenances to the land and
improvements, permanently affixed equipment, and machinery and other fixtures
relating to the operation of the leased properties. There are multiple bundles
of leased properties under each Master Lease Agreement (other than the Corydon
Lease) with each bundle containing approximately seven to twelve leased
properties. All leased properties within a bundle have the same primary terms,
ranging from 10 to 15 years (the "Base Term"). At the option of the Company,
all, but not less than all, of the leased properties in a bundle may be
extended for one five-year renewal term beyond the Base Term (the "First
Renewal Term") at the then existing rental rate plus 2% per annum. At the
option of the Company, all, but not less than all, of the leased properties in
a bundle may be extended for two additional five-year renewal terms beyond the
First Renewal Term (together with the First Renewal Term, the "Renewal Term")
at the then fair market value rental rate. The Base Term and Renewal Term of
each leased property are subject to termination upon default by either party
and certain other conditions described in the Master Lease Agreements.
The Master Lease Agreements are structured as triple-net leases or absolute-
net leases. In addition to the aggregate annual rent plus 2% per annum
escalator over the previous twelve-month period if certain lessee revenue
parameters are obtained, the Company is required to pay all insurance, taxes,
utilities and maintenance related to the leased properties. Rent expense
related to Ventas in 2000, 1999 and in 1998 (eight months) aggregated $230
million, $225 million and $148 million, respectively. In connection with the
Chapter 11 Cases, the Company and Ventas entered into the Stipulation which
provides for the payment by the Company of a reduced aggregate monthly rent of
approximately $15.1 million beginning in September 1999. The difference between
the $19.3 million aggregate monthly rent under the Master Lease Agreements and
the reduced monthly rent under the Stipulation is being accrued as an
administrative expense subject to compromise in the Chapter 11 Cases. During
the pendency of the Chapter 11 Cases, the Company is recording the entire
contractual amount of the aggregate monthly rent.
An "Event of Default" will be deemed to have occurred under any Master Lease
Agreement if, among other things, the Company fails to pay rent or other
amounts within five days after notice; the Company fails to comply with
covenants continuing for 30 days or, so long as diligent efforts to cure such
failure are being made, such longer period (not to exceed 180 days) as is
necessary to cure such failure; certain bankruptcy or insolvency events occur,
including filing a petition of bankruptcy or a petition for reorganization
under the Bankruptcy Code; the Company ceases to operate any leased property as
a provider of healthcare services for a
F-33
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 17--TRANSACTIONS WITH VENTAS (Continued)
Master Lease Agreements (Continued)
period of 30 days; the Company loses any required healthcare license, permit or
approval; the Company fails to maintain insurance; the Company creates or
allows to remain certain liens; a reduction occurs in the number of licensed
beds in excess of 10% of the number of licensed beds in the applicable facility
on the date the applicable facility was leased; certification for reimbursement
under Medicare with respect to a participating facility is revoked; there is
any breach of any material representation or warranty of the Company; the
Company becomes subject to regulatory sanctions and has failed to cure or
satisfy such regulatory sanctions within its specified cure period in any
material respect with respect to any facility; or there is any default under
any guaranty of the lease or under certain indemnity agreements between the
Company and Ventas.
Except as noted below, upon an Event of Default under a particular Master
Lease Agreement, Ventas may, at its option, exercise the following remedies:
(a) after not less than ten days' notice to the Company, terminate the Master
Lease Agreement, repossess the leased property and relet the leased property to
a third party and require the Company pay to Ventas, as liquidated damages, the
net present value of the rent for the balance of the term, discounted at the
prime rate; (b) without terminating the Master Lease Agreement, repossess the
leased property and relet the leased property with the Company remaining liable
under the Master Lease Agreement for all obligations to be performed by the
Company thereunder, including the difference, if any, between the rent under
the Master Lease Agreement and the rent payable as a result of the reletting of
the leased property; and (c) seek any and all other rights and remedies
available under law or in equity.
Certain Events of Default are considered facility-specific events of default.
A facility-specific event of default is caused by (a) the loss of any required
healthcare license, permit or approval, (b) a reduction in the number of
licensed beds in excess of 10% of the number of licensed beds in the applicable
facility or a revocation of certification for reimbursement under Medicare with
respect to any facility that participates in such programs, or (c) the Company
becoming subject to regulatory sanctions and failing to cure or satisfy such
regulatory sanctions within its specified cure period. Upon the occurrence of a
facility-specific event of default, Ventas may, if it so desires, terminate the
related Master Lease Agreement with respect to only the applicable facility
that is the subject of the facility-specific event of default and collect
liquidated damages attributable to such facility multiplied by the number of
years remaining on the applicable lease; provided, however, that upon the
occurrence of the fifth facility-specific event of default, determined on a
cumulative basis, Ventas would be permitted to exercise all of the rights and
remedies set forth in the Master Lease Agreement with respect to all facilities
covered under the Master Lease Agreement, without regard to the facility from
which such fifth facility-specific event of default emanated.
Any remedies provided under the Master Lease Agreements currently are subject
to the supervision of the Bankruptcy Court. See Note 3.
Development Agreement
Under the terms of the Development Agreement, the Company, if it so desires,
will complete the construction of certain development properties substantially
in accordance with the existing plans and specifications for each such
property. Upon completion of each such development property, Ventas has the
option to purchase the development property from the Company at a purchase
price equal to the amount of the Company's actual costs in acquiring,
developing and improving such development property prior to the purchase date.
If Ventas purchases the development property, the Company will lease the
development property from Ventas. The annual base rent under such a lease will
be ten percent of the actual costs incurred by the Company in acquiring and
developing the development property. The other terms of the lease for the
F-34
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 17--TRANSACTIONS WITH VENTAS (Continued)
Development Agreement (Continued)
development property will be substantially similar to those set forth in the
Master Lease Agreements. Since the Spin-off, the Company has sold one skilled
nursing center to Ventas under the Development Agreement for $6.2 million.
Participation Agreement
Under the terms and conditions of the Participation Agreement, the Company
has a right of first offer to become the lessee of any real property acquired
or developed by Ventas which is to be operated as a hospital, nursing center or
other healthcare facility, provided that the Company and Ventas negotiate a
mutually satisfactory lease arrangement.
The Participation Agreement also provides, subject to certain terms, that the
Company will provide Ventas with a right of first offer to purchase or finance
any healthcare related real property that the Company determines to sell or
mortgage to a third party, provided that the Company and Ventas negotiate
mutually satisfactory terms for such purchase or mortgage.
Transition Services Agreement
The Transition Services Agreement provided that the Company provide Ventas
with transitional administrative and support services, including but not
limited to finance and accounting, human resources, risk management, legal, and
information systems support through December 31, 1998. Ventas paid the Company
$1.6 million in 1998 under the Transition Services Agreement.
Tax Allocation Agreement
The Tax Allocation Agreement provides that Ventas will be liable for taxes of
the Ventas consolidated group attributable to periods prior to the Spin-off
with respect to the portion of such taxes attributable to the property held by
Ventas after the Spin-off and the Company will be liable for such pre-
distribution taxes with respect to the portion of such taxes attributable to
the property held by the Company after the Spin-off. The Tax Allocation
Agreement further provides that Ventas will be liable for any taxes
attributable to the Spin-off except that the Company will be liable for any
such taxes to the extent that the Company derives certain future tax benefits
as a result of the payment of such taxes. Ventas and its subsidiaries are
liable for taxes payable with respect to periods after the Spin-off that are
attributable to Ventas operations and the Company and its subsidiaries are
liable for taxes payable with respect to periods after the Spin-off that are
attributable to the Company's operations. If, in connection with a tax audit or
filing of an amended return, a taxing authority adjusts the tax liability of
either the Company or Ventas with respect to taxes for which the other party
was liable under the Tax Allocation Agreement, such other party would be liable
for the resulting tax assessment or would be entitled to the resulting tax
refund. During 1998, $6.7 million was received from Ventas under the Tax
Allocation Agreement. At December 31, 1998, the Company owed Ventas $5.9
million for a tax settlement under the Tax Allocation Agreement (which was
repaid to Ventas in January 1999). This transaction had no impact on earnings.
The Company and Ventas disagree with respect to certain interpretations of
the Tax Allocation Agreement described above. On May 31, 2000, the Company
announced that the Bankruptcy Court had approved a tax stipulation agreement
between the Company and Ventas (the "Tax Stipulation"). The Tax Stipulation
provides that certain refunds of federal, state and local taxes received by
either party on or after September 13, 1999 will be held by the recipient of
such refunds in segregated interest bearing accounts. The Tax Stipulation
requires notification before either party can withdraw funds from the
segregated accounts and will terminate upon the effective date of the Amended
Plan.
F-35
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 18--OTHER RELATED PARTY TRANSACTIONS
In connection with the Spin-off, the Company loaned certain executive
officers an amount equal to the estimated personal income taxes payable by them
as a result of the Spin-off (the "Tax Loans"). Each Tax Loan is evidenced by a
promissory note which has a term of ten years and bears interest at 5.77% per
annum. Principal on the Tax Loans is scheduled to be repaid in ten equal annual
installments which began on June 15, 1999. Interest is payable quarterly;
however, any interest payment on the Tax Loans is forgiven if the officer
remains in his or her position with the Company on the date on which such
interest payment is due. Moreover, in the event of a change in control of the
Company, the entire balance of the Tax Loan will be forgiven. The terms of the
Tax Loans with certain former executive officers were amended in connection
with their severance agreements to provide that the payment of the principal
and interest on the Tax Loans be deferred until the fifth anniversary of their
respective date of termination. All Tax Loans made to current executive
officers have been repaid in full.
As part of the Spin-off, the Company issued $17.7 million of its 6% Series A
Non-Voting Convertible Preferred Stock (the "Preferred Stock") to Ventas as
part of the consideration for the assets transferred from Ventas to the
Company. The Preferred Stock (par value $1,000) includes a ten-year mandatory
redemption provision and is convertible into common stock at a price of $12.50
per share. In connection with the purchases of the Preferred Stock, the Company
loaned certain officers 90% of the purchase price ($15.9 million) of the
Preferred Stock (the "Preferred Stock Loans"). Each Preferred Stock Loan is
evidenced by a promissory note which has a ten year term and bears interest at
5.74%, payable annually. No principal payments are due under the promissory
notes until their maturity. The promissory notes are secured by a first
priority security interest in the Preferred Stock purchased by each such
officer. As of December 31, 2000, $15.7 million of these loans remained
outstanding. The terms of the Preferred Stock Loans with certain former
officers were amended in connection with their severance agreements to provide,
generally, that (a) the Preferred Stock Loan will not be due and payable until
April 30, 2008, (b) payments on the Preferred Stock Loan will be deferred until
the fifth anniversary of the date of termination, (c) interest payments will be
forgiven if the average closing price of the common stock for the 90 days prior
to any interest payment date is less than $8.00 and (d) during the five-day
period following the expiration of the fifth anniversary of the date of
termination, the former officer will have the right to put the Preferred Stock
underlying the Preferred Stock Loan to the Company at par.
In August 1999, the Company entered into agreements with certain officers
which permit such officer to put the Preferred Stock to the Company for an
amount equal to the outstanding principal and interest on the officer's
Preferred Stock Loan (the "Preferred Stock Agreements"). The officer could put
the Preferred Stock to the Company after January 1, 2000. During the Chapter 11
Cases, the Company cannot honor the terms of the Preferred Stock Agreements.
The Preferred Stock Agreements were entered into with each officer employed by
the Company in August 1999 who owned the Preferred Stock.
NOTE 19--FAIR VALUE DATA
A summary of fair value data at December 31 follows (in thousands):
2000 1999
----------------- -----------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- -------- -------- --------
Cash and cash equivalents............... $184,642 $184,642 $148,350 $148,350
Insurance subsidiary investments........ 62,453 62,453 16,483 16,483
Restricted funds (included in other
current assets)........................ 10,674 10,674 9,522 9,522
Long-term debt, including amounts due
within one
year................................... 879,577 537,330 893,393 485,314
Interest rate swap agreements (included
in long-term
debt).................................. - - - 157
F-36
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION
Summary descriptions of various significant legal and regulatory activities
follow.
On September 13, 1999, the Company and substantially all of its subsidiaries
filed voluntary petitions for protection under Chapter 11 of the Bankruptcy
Code. The Chapter 11 Cases have been styled In re: Vencor, Inc., et al.,
Debtors and Debtors in Possession, Case Nos. 99-3199 (MFW) through 99-3327
(MFW), Chapter 11, Jointly Administered. On December 14, 2000, the Company
filed its Amended Plan with the Bankruptcy Court. On March 1, 2001, the
Bankruptcy Court approved the Company's Amended Plan and an order was entered
confirming the Amended Plan on March 16, 2001. See Note 3 for further
discussion of the Chapter 11 Cases.
On March 18, 1999, the Company served Ventas with a demand for mediation
pursuant to the Spin-off Agreement. The Company was seeking a reduction in rent
and other concessions under its Master Lease Agreements with Ventas. On March
31, 1999, the Company and Ventas entered into a standstill agreement which
provided that both companies would postpone through April 12, 1999 any claims
either may have against the other. On April 12, 1999, the Company and Ventas
entered into a second standstill which provided that neither party would pursue
any claims against the other or any other third party related to the Spin-off
as long as the Company complied with certain rent payment terms. The second
standstill was scheduled to terminate on May 5, 1999. Pursuant to a tolling
agreement, the Company and Ventas also agreed that any statutes of limitations
or other time-related constraints in a bankruptcy or other proceeding that
might be asserted by one party against the other would be extended and tolled
from April 12, 1999 until May 5, 1999 or until the termination of the second
standstill. As a result of the Company's failure to pay rent, Ventas served the
Company with notices of nonpayment under the Master Lease Agreements.
Subsequently, the Company and Ventas entered into further amendments to the
second standstill and the tolling agreement to extend the time during which no
remedies may be pursued by either party and to extend the date by which the
Company may cure its failure to pay rent.
In connection with the Chapter 11 Cases, the Company and Ventas entered into
the Stipulation that provides for the payment by the Company of a reduced
aggregate monthly rent of approximately $15.1 million. The Stipulation has been
approved by the Bankruptcy Court. The Stipulation also continues to toll any
statutes of limitations or other time constraints in a bankruptcy proceeding
for claims that might be asserted by the Company against Ventas. The
Stipulation automatically renews for one-month periods unless either party
provides a 14-day notice of termination. The Stipulation also may be terminated
prior to its expiration upon a payment default by the Company, the consummation
of a plan of reorganization or the occurrence of certain defaults under the DIP
Financing. The Stipulation also provides that the Company will continue to
fulfill its indemnification obligations arising from the Spin-off. The
Stipulation will terminate upon the effective date of the Amended Plan.
The Company believes that the Amended Plan, if consummated, will resolve all
material disputes between the Company and Ventas. The Amended Plan also
provides for comprehensive mutual releases between the Company and Ventas,
other than for obligations that the Company is assuming under the Amended Plan.
If the Amended Plan does not become effective and the Company and Ventas are
unable to otherwise resolve their disputes or maintain an interim resolution,
the Company may seek to pursue claims against Ventas arising out of the Spin-
off and seek judicial relief barring Ventas from exercising any remedies based
on the Company's failure to pay some or all of the rent to Ventas. The
Company's failure to pay rent or otherwise comply with the Stipulation, in the
absence of judicial relief, would result in an "Event of Default" under the
Master Lease Agreements. Upon an Event of Default under the Master Lease
Agreements, assuming Ventas were to be granted relief from the automatic stay
by the Bankruptcy Court, the remedies available to Ventas include, without
limitation, terminating the Master Lease Agreements, repossessing and reletting
the leased
F-37
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
properties and requiring the Company to (a) remain liable for all obligations
under the Master Lease Agreements, including the difference between the rent
under the Master Lease Agreements and the rent payable as a result of reletting
the leased properties or (b) pay the net present value of the rent due for the
balance of the terms of the Master Lease Agreements. Such remedies, however,
would be subject to the supervision of the Bankruptcy Court.
The Company's subsidiary, formerly named TheraTx, Incorporated, is plaintiff
in a declaratory judgment action entitled TheraTx, Incorporated v. James W.
Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States District
Court for the Northern District of Georgia and currently pending in the United
States Court of Appeals for the Eleventh Circuit, No. 99-11451-FF. The
defendants have asserted counterclaims against TheraTx under breach of
contract, securities fraud, negligent misrepresentation and other fraud
theories for allegedly not performing as promised under a merger agreement
related to TheraTx's purchase of a company called PersonaCare, Inc. and for
allegedly failing to inform the defendants/counterclaimants prior to the merger
that TheraTx's possible acquisition of Southern Management Services, Inc. might
cause the suspension of TheraTx's shelf registration under relevant rules of
the Securities and Exchange Commission (the "Commission"). The court granted
summary judgment for the defendants/counterclaimants and ruled that TheraTx
breached the shelf registration provision in the merger agreement, but
dismissed the defendants' remaining counterclaims. Additionally, the court
ruled after trial that defendants/counterclaimants were entitled to damages and
prejudgment interest in the amount of approximately $1.3 million and attorneys'
fees and other litigation expenses of approximately $700,000. The Company and
the defendants/counterclaimants both appealed the court's rulings. The Court of
Appeals for the Eleventh Circuit affirmed the trial court's rulings with the
exception of the damages award and certified the question of the proper
calculation of damages under Delaware law to the Delaware Supreme Court. The
Company is defending the action vigorously.
The Company is pursuing various claims against private insurance companies
who issued Medicare supplement insurance policies to individuals who became
patients of the Company's hospitals. After the patients' Medicare benefits are
exhausted, the insurance companies become liable to pay the insureds' bills
pursuant to the terms of these policies. The Company has filed numerous
collection actions against various of these insurers to collect the difference
between what Medicare would have paid and the hospitals' usual and customary
charges. These disputes arise from differences in interpretation of the policy
provisions and federal and state laws governing such policies. Various courts
have issued various rulings on the different issues, some of which have been
adverse to the Company and most of which have been appealed. The Company
intends to continue to pursue these claims vigorously. If the Company does not
prevail on these issues, future results of operations and liquidity would be
materially adversely affected.
A class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al., was
filed on December 24, 1997 in the United States District Court for the Western
District of Kentucky (Civil Action No. 3-97CV-8354). The class action claims
were brought by an alleged stockholder of the Company's predecessor against the
Company and Ventas and certain current and former executive officers and
directors of the Company and Ventas. The complaint alleges that the Company,
Ventas and certain current and former executive officers of the Company and
Ventas during a specified time frame violated Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 (the "Exchange Act"), by, among other things,
issuing to the investing public a series of false and misleading statements
concerning Ventas' then current operations and the inherent value of its common
stock. The complaint further alleges that as a result of these purported false
and misleading statements concerning Ventas' revenues and successful
acquisitions, the price of the common stock was artificially inflated. In
particular, the complaint alleges that the defendants issued false and
misleading financial statements during the first, second and third calendar
quarters of 1997 which misrepresented and understated the impact that changes
in Medicare reimbursement policies would have on Ventas' core services and
profitability. The complaint
F-38
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
further alleges that the defendants issued a series of materially false
statements concerning the purportedly successful integration of Ventas'
acquisitions and prospective earnings per share for 1997 and 1998 which the
defendants knew lacked any reasonable basis and were not being achieved. The
suit seeks damages in an amount to be proven at trial, pre-judgment and post-
judgment interest, reasonable attorneys' fees, expert witness fees and other
costs, and any extraordinary equitable and/or injunctive relief permitted by
law or equity to assure that the plaintiff has an effective remedy. In December
1998, the defendants filed a motion to dismiss the case. The court converted
the defendants' motion to dismiss into a motion for summary judgment and
granted summary judgment as to all defendants. The plaintiff appealed the
ruling to the United States Court of Appeals for the Sixth Circuit. On
April 24, 2000, the Sixth Circuit affirmed the district court's dismissal of
the action on the grounds that the plaintiff failed to state a claim upon which
relief could be granted. On July 14, 2000, the Sixth Circuit granted the
plaintiff's petition for a rehearing en banc. The Company is defending this
action vigorously.
A shareholder derivative suit entitled Thomas G. White on behalf of Vencor,
Inc. and Ventas, Inc. v. W. Bruce Lunsford, et al., Case No. 98CI03669, was
filed in June 1998 in the Jefferson County, Kentucky, Circuit Court. The suit
was brought on behalf of the Company and Ventas against certain current and
former executive officers and directors of the Company and Ventas. The
complaint alleges that the defendants damaged the Company and Ventas by
engaging in violations of the securities laws, engaging in insider trading,
fraud and securities fraud and damaging the reputation of the Company and
Ventas. The plaintiff asserts that such actions were taken deliberately, in bad
faith and constitute breaches of the defendants' duties of loyalty and due
care. The complaint is based on substantially similar assertions to those made
in the class action lawsuit entitled A. Carl Helwig v. Vencor, Inc., et al.,
discussed above. The suit seeks unspecified damages, interest, punitive
damages, reasonable attorneys' fees, expert witness fees and other costs, and
any extraordinary equitable and/or injunctive relief permitted by law or equity
to assure that the Company and Ventas have an effective remedy. The Company
believes that the allegations in the complaint are without merit and intends to
defend this action vigorously.
A class action lawsuit entitled Jules Brody v. Transitional Hospitals
Corporation, et al., Case No. CV-S-97-00747-PMP, was filed on June 19, 1997 in
the United States District Court for the District of Nevada on behalf of a
class consisting of all persons who sold shares of Transitional common stock
during the period from February 26, 1997 through May 4, 1997, inclusive. The
complaint alleges that Transitional purchased shares of its common stock from
members of the investing public after it had received a written offer to
acquire all of the Transitional common stock and without making the required
disclosure that such an offer had been made. The complaint further alleges that
defendants disclosed that there were "expressions of interest" in acquiring
Transitional when, in fact, at that time, the negotiations had reached an
advanced stage with actual firm offers at substantial premiums to the trading
price of Transitional's stock having been made which were actively being
considered by Transitional's Board of Directors. The complaint asserts claims
pursuant to Sections 10(b), 14(e) and 20(a) of the Exchange Act, and common law
principles of negligent misrepresentation and names as defendants Transitional
as well as certain former senior executives and directors of Transitional. The
plaintiff seeks class certification, unspecified damages, attorneys' fees and
costs. In June 1998, the court granted the Company's motion to dismiss with
leave to amend the Section 10(b) claim and the state law claims for
misrepresentation. The court denied the Company's motion to dismiss the Section
14(e) and Section 20(a) claims, after which the Company filed a motion for
reconsideration. On March 23, 1999, the court granted the Company's motion to
dismiss all remaining claims and the case was dismissed. The plaintiff has
appealed this ruling to the United States Court of Appeals for the Ninth
Circuit. The Company is defending this action vigorously.
F-39
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
On April 14, 1999, a lawsuit entitled Lenox Healthcare, Inc., et al. v.
Vencor, Inc., et al., Case No. BC 208750, was filed in the Superior Court of
Los Angeles, California by Lenox Healthcare, Inc. ("Lenox") asserting various
causes of action arising out of the Company's sale and lease of several nursing
centers to Lenox in 1997. Lenox subsequently removed certain of its causes of
action and refiled these claims before the United States District Court for the
Western District of Kentucky in a case entitled Lenox Healthcare, Inc. v.
Vencor, Inc., et al., Case No. 3:99 CV-348-H. The Company asserted
counterclaims, including RICO claims, against Lenox in the Kentucky action. The
Company believes that the allegations made by Lenox in both complaints are
without merit. Lenox and its subsidiaries filed for protection under Chapter 11
of the Bankruptcy Code on November 3, 1999. By virtue of both the Company's and
Lenox's separate filings for Chapter 11 protection, the two Lenox actions and
the Company's counterclaims were stayed. Subsequently, the parties entered into
a settlement, which was approved by their respective bankruptcy courts, that
requires the dismissal of the two above actions. Joint motions to dismiss have
been filed by the parties in each court.
The Company was informed by the DOJ that the Company and Ventas are the
subjects of investigations into various Medicare reimbursement issues,
including hospital cost reporting issues, Vencare billing practices and various
quality of care issues in the hospitals and nursing centers formerly operated
by Ventas and currently operated by the Company. These investigations include
some matters for which the Company indemnified Ventas in the Spin-off. In cases
where neither the Company nor any of its subsidiaries are defendants but Ventas
is the defendant, the Company had agreed to defend and indemnify Ventas for
such claims as part of the Spin-off. The Stipulation entered into with Ventas
provides that the Company will continue to fulfill its indemnification
obligations arising from the Spin-off. The Company has cooperated fully in the
investigations.
The DOJ has informed the Company that it has intervened in several pending
qui tam actions asserted against the Company and/or Ventas in connection with
these investigations. In addition, the DOJ has filed proofs of claims with
respect to certain alleged claims in the Chapter 11 Cases. The Company, Ventas
and the DOJ have finalized the terms of the Government Settlement which will
resolve all of the DOJ investigations including the pending qui tam actions.
The Government Settlement provides that within 30 days after the Amended Plan
becomes effective, the Government will move to dismiss with prejudice to the
United States and the relators (except for certain claims which will be
dismissed without prejudice to the United States in certain of these cases) the
pending qui tam actions as against any or all of the Company and its
subsidiaries, Ventas and any current or former officers, directors and
employees of either entity. There can be no assurance that each court before
which a qui tam action is pending will dismiss the case on the DOJ's motion.
The following is a summary of the qui tam actions pending against the Company
and/or Ventas in which the DOJ has intervened. In connection with the DOJ's
intervention, the courts ordered these previously non-public actions to be
unsealed. Certain of the actions described below name other defendants in
addition to the Company and Ventas.
(a) The Company, Ventas and the Company's subsidiary, American X-Rays,
Inc. ("AXR"), are defendants in a civil qui tam action styled United States
ex rel. Doe v. American X-Rays Inc., et al., No. LR-C-95-332, pending in
the United States District Court for the Eastern District of Arkansas and
served on AXR on July 7, 1997. The DOJ intervened in the suit which was
brought under the Federal Civil False Claims Act and added the Company and
Ventas as defendants. The Company acquired an interest in AXR when The
Hillhaven Corporation was merged into the Company in September 1995 and
purchased the remaining interest in AXR in February 1996. AXR provided
portable X-ray services to nursing centers (including some of those
operated by Ventas or the Company) and other healthcare
F-40
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
providers. The civil suit alleges that AXR submitted false claims to the
Medicare and Medicaid programs. The suit seeks damages in an amount of not
less than $1,000,000, treble damages and civil penalties. The Company has
defended this action vigorously. The court has dismissed the action based
upon the possible pending settlement between the DOJ, the Company and
Ventas. In a related criminal investigation, the United States Attorney's
Office for the Eastern District of Arkansas ("USAO") indicted four former
employees of AXR; those individuals were convicted of various fraud related
counts in January 1999. AXR had been informed previously that it was not a
target of the criminal investigation, and AXR was not indicted. However,
the Company received several grand jury subpoenas for documents and
witnesses which it moved to quash. The USAO has withdrawn the subpoenas
which rendered the motion moot.
(b) The Company's subsidiary, Medisave Pharmacies, Inc. ("Medisave"),
Ventas and Hillhaven (former parent company to Medisave), are the
defendants in a civil qui tam action styled United States ex rel. Danley v.
Medisave Pharmacies, Inc., et al., No. CV-N-96-00170-HDM, filed in the
United States District Court for the District of Nevada on March 15, 1996.
The plaintiff alleges that Medisave, an institutional pharmacy provider,
formerly owned by Ventas and owned by the Company since the Spin-off: (1)
charged the Medicare program for unit dose drugs when bulk drugs were
administered and charged skilled nursing facilities more for the same drugs
for Medicare patients than for non-Medicare patients; (2) improperly
claimed special dispensing fees that it was not entitled to under Medicaid;
and (3) recouped unused drugs from skilled nursing facilities and returned
these drugs to its stock without crediting Medicare or Medicaid, all in
violation of the Federal Civil False Claims Act. The complaint also alleges
that Medisave had a policy of offering kickbacks, such as free equipment,
to skilled nursing centers to secure and maintain their business. The
complaint seeks treble damages, other unspecified damages, civil penalties,
attorneys' fees and other costs. The Company disputes the allegations in
the complaint. The defendants intend to defend this action vigorously.
(c) Ventas and the Company's subsidiary, Vencare, Inc. ("Vencare"), among
others, are defendants in the action styled United States ex rel. Roberts
v. Vencor, Inc., et al., No. 3:97CV-349-J, filed in the United States
District Court for the Western District of Kansas on June 25, 1996 and
consolidated with the action styled United States of America ex rel.
Meharg, et al. v. Vencor, Inc., et al., No. 3:98SC-737-H, filed in the
United States District Court for the Middle District of Florida on June 4,
1998. The complaint alleges that the defendants knowingly submitted and
conspired to submit false claims and statements to the Medicare program in
connection with their purported provision of respiratory therapy services
to skilled nursing center residents. The defendants allegedly billed
Medicare for respiratory therapy services and supplies when those services
were not medically necessary, billed for services not provided, exaggerated
the time required to provide services or exaggerated the productivity of
their therapists. It is further alleged that the defendants presented false
claims and statements to the Medicare program in violation of the Federal
Civil False Claims Act, by, among other things, allegedly causing skilled
nursing centers with which they had respiratory therapy contracts, to
present false claims to Medicare for respiratory therapy services and
supplies. The complaint seeks treble damages, other unspecified damages,
civil penalties, attorneys' fees and other costs. The Company disputes the
allegations in the complaint. The defendants intend to defend this action
vigorously.
(d) In United States ex rel. Kneepkens v. Gambro Healthcare, Inc., et
al., No. 97-10400-GAO, filed in the United States District Court for the
District of Massachusetts on October 15, 1998, the Company's subsidiary,
Transitional, and two unrelated entities, Gambro Healthcare, Inc. and
Dialysis Holdings, Inc., are defendants in this suit alleging that they
violated the Federal Civil False Claims Act and the Medicare and Medicaid
antikickback, antifraud and abuse regulations and committed common law
fraud, unjust enrichment and payment by mistake of fact. Specifically, the
complaint alleges that a predecessor to
F-41
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
Transitional formed a joint venture with Damon Clinical Laboratories to
create and operate a clinical testing laboratory in Georgia that was then
used to provide lab testing for dialysis patients, and that the joint
venture billed at below cost in return for referral of substantially all
non-routine testing in violation of Medicare and Medicaid antikickback and
antifraud regulations. It is further alleged that a predecessor to
Transitional and Damon Clinical Laboratories used multiple panel testing of
end stage renal disease rather than single panel testing that allegedly
resulted in the generation of additional revenues from Medicare and that
the entities allegedly added non-routine tests to tests otherwise ordered
by physicians that were not requested or medically necessary but resulted
in additional revenue from Medicare in violation of the antikickback and
antifraud regulations. Transitional has moved to dismiss the case.
Transitional disputes the allegations in the complaint and is defending the
action vigorously.
(e) The Company and/or Ventas are defendants in the action styled United
States ex rel. Huff and Dolan v. Vencor, Inc., et al., No. 97-4358 AHM
(Mcx), filed in the United States District Court for the Central District
of California on June 13, 1997. The plaintiff alleges that the defendant
violated the Federal Civil False Claims Act by submitting false claims to
the Medicare, Medicaid and CHAMPUS programs by allegedly: (1) falsifying
patient bills and submitting the bills to the Medicare, Medicaid and
CHAMPUS programs, (2) submitting bills for intensive and critical care not
actually administered to patients, (3) falsifying patient charts in
relation to the billing, (4) charging for physical therapy services
allegedly not provided and pharmacy services allegedly provided by non-
pharmacists, and (5) billing for sales calls made by nurses to prospective
patients. The complaint seeks treble damages, other unspecified damages,
civil penalties, attorneys' fees and other costs. Defendants dispute the
allegations in the complaint. The Company, on behalf of itself and Ventas,
intends to defend this action vigorously.
(f) Ventas is the defendant in the action styled United States ex rel.
Brzycki v. Vencor, Inc., Civ. No. 97-451-JD, filed in the United States
District Court for the District of New Hampshire on September 8, 1997.
Ventas is alleged to have knowingly violated the Federal Civil False Claims
Act by submitting and conspiring to submit false claims to the Medicare
program. The complaint alleges that Ventas: (1) fabricated diagnosis codes
by ordering medically unnecessary services, such as respiratory therapy;
(2) changed referring physicians' diagnoses in order to qualify for
Medicare reimbursement; and (3) billed Medicare for oxygen use by patients
regardless of whether the oxygen was actually administered to particular
patients. The complaint further alleges that Ventas paid illegal kickbacks
to referring healthcare professionals in the form of medical consulting
service agreements as an alleged inducement to refer patients, in violation
of the Federal Civil False Claims Act, the antikickback and antifraud
regulations and the Stark provisions. It is additionally alleged that
Ventas consistently submitted Medicare claims for clinical services that
were not performed or were performed at lower actual costs. The complaint
seeks unspecified damages, civil penalties, attorneys' fees and costs.
Ventas disputes the allegations in the complaint. The Company, on behalf of
Ventas, intends to defend the action vigorously.
(g) United States ex rel. Lanford and Cavanaugh v. Vencor, Inc., et al.,
Civ. No. 97-CV-2845, was filed against Ventas in the United States District
Court for the Middle District of Florida, on November 24, 1997. The United
States of America intervened in this civil qui tam lawsuit on May 17, 1999.
On July 23, 1999, the United States filed its amended complaint in the
lawsuit and added the Company as a defendant. The lawsuit alleges that the
Company and Ventas knowingly submitted false claims and false statements to
the Medicare and Medicaid programs including, but not limited to, claims
for reimbursement of costs for certain ancillary services performed in
defendants' nursing centers and for third-party nursing center operators
that the United States alleges are not properly reimbursable costs through
the hospitals' cost reports. The lawsuit involves the Company's hospitals
which were owned by Ventas prior to the Spin-off. The complaint does not
specify the amount of damages sought. The Company and Ventas dispute the
allegations in the amended complaint and intend to defend this action
vigorously.
F-42
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
(h) In United States ex rel. Harris and Young v. Vencor, Inc., et al.,
filed in the Eastern District of Missouri on May 25, 1999, the defendants
include the Company, Vencare, and Ventas. The defendants allegedly
submitted and conspired to submit false claims for payment to the Medicare
and CHAMPUS programs, in violation of the Federal Civil False Claims Act.
According to the complaint, the Company, through its subsidiary, Vencare,
allegedly (1) over billed for respiratory therapy services, (2) rendered
medically unnecessary treatment, and (3) falsified supply, clinical and
equipment records. The defendants also allegedly encouraged or instructed
therapists to falsify clinical records and over prescribe therapy services.
The complaint seeks treble damages, other unspecified damages, civil
penalties, attorneys' fees and other costs. The Company disputes the
allegations in the complaint and intends to defend this action vigorously.
The action has been dismissed with prejudice as to the relator and without
prejudice as to the United States.
(i) In United States ex rel. George Mitchell, et al. v. Vencor, Inc., et
al., filed in the United States District Court for the Southern District of
Ohio on August 13, 1999, the defendants, consisting of the Company and its
two subsidiaries, Vencare and Vencor Hospice, Inc., are alleged to have
violated the Federal Civil False Claims Act by obtaining improper
reimbursement from Medicare concerning the treatment of hospice patients.
Defendants are alleged to have obtained inflated Medicare reimbursement for
admitting, treating and/or failing to discharge in a timely manner hospice
patients who were not "hospice appropriate." The complaint further alleges
that the defendants obtained inflated reimbursement for providing
medications for these hospice patients. The complaint alleges damages in
excess of $1,000,000. The Company disputes the allegations in the complaint
and intends to defend vigorously the action.
(j) In Gary Graham, on Behalf of the United States of America v. Vencor
Operating, Inc. et. al., filed in the United States District Court for the
Southern District of Florida on or about June 8, 1999, the defendants,
including the Company, its subsidiary, Vencor Operating, Inc., Ventas,
Hillhaven and Medisave, are alleged to have presented or caused to be
presented false or fraudulent claims for payment to the Medicare program in
violation of, among other things, the Federal Civil False Claims Act. The
complaint alleges that Medisave, a subsidiary of the Company which was
transferred from Ventas to the Company in the Spin-off, systematically up-
charged for drugs and supplies dispensed to Medicare patients. The
complaint seeks unspecified damages, civil penalties, interest, attorneys'
fees and other costs. The Company disputes the allegations in the complaint
and intends to defend this action vigorously.
(k) In United States, et al., ex rel. Phillips-Minks, et al. v.
Transitional Corp., et al., filed in the United States District Court for
Southern District of California on July 23, 1998, the defendants, including
Transitional and Ventas, are alleged to have submitted and conspired to
submit false claims and statements to Medicare, Medicaid, and other federal
and state funded programs during a period commencing in 1993. The conduct
complained of allegedly violates the Federal Civil False Claims Act, the
California False Claims Act, the Florida False Claims Act, the Tennessee
Health Care False Claims Act, and the Illinois Whistleblower Reward and
Protection Act. The defendants allegedly submitted improper and erroneous
claims to Medicare, Medicaid and other programs, for improper or
unnecessary services and services not performed, inadequate collections
efforts associated with billing and collecting bad debts, inflated and
nonexistent laboratory charges, false and inadequate documentation of
claims, splitting charges, shifting revenues and expenses, transferring
patients to hospitals that are reimbursed by Medicare at a higher level,
failing to return duplicate reimbursement payments, and improperly
allocating hospital insurance expenses. In addition, the complaint alleges
that the defendants were inconsistent in their reporting of cost report
data, paid kickbacks to increase patient referrals to hospitals, and
incorrectly reported employee compensation resulting in inflated employee
401(k) contributions. The complaint seeks unspecified
F-43
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 20--LITIGATION (Continued)
damages. The Company disputes the allegations in the complaint and intends
to defend this action vigorously.
In connection with the Spin-off, liabilities arising from various legal
proceedings and other actions were assumed by the Company and the Company
agreed to indemnify Ventas against any losses, including any costs or expenses,
it may incur arising out of or in connection with such legal proceedings and
other actions. The indemnification provided by the Company also covers losses,
including costs and expenses, which may arise from any future claims asserted
against Ventas based on the former healthcare operations of Ventas. In
connection with its indemnification obligation, the Company has assumed the
defense of various legal proceedings and other actions. The Stipulation entered
into with Ventas provides that the Company will continue to fulfill its
indemnification obligations arising from the Spin-off.
The Company is a party to certain legal actions and regulatory investigations
arising in the normal course of its business. The Company is unable to predict
the ultimate outcome of pending litigation and regulatory investigations. In
addition, there can be no assurance that the DOJ, HCFA or other regulatory
agencies will not initiate additional investigations related to the Company's
businesses in the future, nor can there be any assurance that the resolution of
any litigation or investigations, either individually or in the aggregate,
would not have a material adverse effect on the Company's results of
operations, liquidity or financial position. In addition, the above litigation
and investigations (as well as future litigation and investigations) are
expected to consume the time and attention of the Company's management and may
have a disruptive effect upon the Company's operations.
NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION
On March 1, 2001, the Bankruptcy Court approved the Amended Plan. The order
confirming the Amended Plan was entered on March 16, 2001. The Amended Plan
must be effective no later than May 1, 2001.
In connection with the confirmation hearing, the Company entered into a
commitment letter for the Exit Facility. The Exit Facility will be available to
fund the Company's obligations under the Amended Plan and its ongoing
operations following emergence from bankruptcy.
The consummation of the Amended Plan is subject to a number of material
conditions including, without limitation, the negotiation and execution of
definitive agreements for the Exit Facility. There can be no assurance that the
Amended Plan will be consummated.
Amended Plan of Reorganization
The Amended Plan represents a consensual arrangement among Ventas, the
Company's senior bank lenders (the "Senior Lenders"), holders of the 1998
Notes, the DOJ, acting on behalf of the Department of Health and Human
Services' Office of the Inspector General (the "OIG") and HCFA (collectively,
the "Government") and the advisors to the official committee of unsecured
creditors.
The Company distributed its disclosure materials soliciting approval of the
Amended Plan on December 29, 2000. Voting on the Amended Plan concluded on
February 15, 2001 (other than for Ventas, which voted prior to the confirmation
hearing) and the Company received the requisite acceptances from various
creditor classes to confirm the Amended Plan.
F-44
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION (Continued)
Amended Plan of Reorganization (Continued)
The following is a summary of certain material provisions of the Amended
Plan. The summary does not purport to be complete and is qualified in its
entirety by reference to all of the provisions of the Amended Plan, including
all exhibits and documents described therein, as filed with the Bankruptcy
Court and as may otherwise be amended, modified or supplemented.
The Amended Plan provides for, among other things, the following
distributions:
Senior Lender Claims--The Senior Lenders will receive, in the aggregate, new
senior subordinated secured notes in the principal amount of $300 million,
bearing interest at the rate of LIBOR plus 4 1/2%, with a maturity of seven
years (the "New Senior Secured Notes"). The interest on the New Senior Secured
Notes will begin to accrue approximately two quarters following the effective
date of the Amended Plan and, in lieu of interest payments, the Company will
pay a $25.9 million obligation under the Government Settlement within the first
two full fiscal quarters following the effective date of the Amended Plan as
described below. In addition, holders of the Senior Lender claims will receive
an aggregate distribution of 65.51% of the new common stock (the "New Common
Stock") of the reorganized Company (subject to dilution from stock issuances
occurring after the effective date of the Amended Plan).
Senior Subordinated Noteholder Claims--The holders of the 1998 Notes and the
remaining $2.4 million of the Company's 8 5/8% Senior Subordinated Notes due
2007 (collectively, the "Subordinated Noteholder Claims") will receive, in the
aggregate, 24.50% of the New Common Stock (subject to dilution from stock
issuances occurring after the effective date of the Amended Plan). In addition,
the holders of the Subordinated Noteholder Claims will receive, in the
aggregate, warrants issued by the Company for the purchase of an aggregate of
7,000,000 shares of New Common Stock, with a five-year term, which will consist
of warrants to purchase 2,000,000 shares at a price per share of $30.00, and
warrants to purchase 5,000,000 shares at a price per share of $33.33.
Ventas Claim--Ventas will receive the following treatment under the Amended
Plan:
The four master leases and the Corydon Lease with Ventas will be assumed and
simultaneously amended and restated as of the effective date of the Amended
Plan (the "Amended Leases"). The principal economic terms of the Amended Leases
are as follows:
(1) A decrease of $52 million in the aggregate minimum rent from the
annual rent as of May 1, 1999 to a new initial aggregate minimum rent of
$174.6 million as of the first month after the effective date of the
Amended Plan.
(2) Annual aggregate minimum rent payable in cash will escalate at an
annual rate of 3.5% over the prior period annual aggregate minimum rent for
the period from May 1, 2001 through April 30, 2004. Thereafter, annual
aggregate minimum rent payable in cash will escalate at an annual rate of
2%, plus an additional annual accrued escalator amount of 1.5% of the prior
period annual aggregate minimum rent which will accrete from year to year
(with an interest accrual at LIBOR plus 4 1/2%). All accrued rent will be
payable upon the repayment or refinancing of the New Senior Secured Notes,
after which the annual aggregate minimum rent payable in cash will escalate
at an annual rate of 3.5% and there will be no further accrual feature.
(3) A one-time option, that can be exercised by Ventas 5 1/4 years after
the effective date of the Amended Plan, to reset the annual aggregate
minimum rent under one or more of the Amended Leases to the then current
fair market rental in exchange for a payment of $5 million (or a pro rata
portion thereof if fewer than all of the Amended Leases are reset) to the
Company.
F-45
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION (Continued)
Amended Plan of Reorganization (Continued)
(4) Under the Amended Leases, the "Event of Default" provisions also will
be substantially modified and will provide Ventas with more flexibility in
exercising remedies for events of default.
In addition to the Amended Leases, Ventas will receive a distribution of
9.99% of the New Common Stock (subject to dilution from stock issuances
occurring after the effective date of the Amended Plan).
Ventas also will enter into a tax escrow agreement with the Company as of the
effective date that will provide for the escrow of approximately $30 million of
federal, state and local refunds until the expiration of the applicable
statutes of limitation for the auditing of the refund applications. The
escrowed funds will be available for the payment of certain tax deficiencies
during the escrow period except that all interest paid by the government in
connection with any refund or earned on the escrowed funds will be distributed
equally to the parties. At the end of the escrow period, the Company and Ventas
will each be entitled to 50% of any proceeds remaining in the escrow account.
All agreements and indemnification obligations between the Company and
Ventas, except those modified by the Amended Plan, will be assumed by the
Company as of the effective date of the Amended Plan.
United States Claims--The claims of the Government (other than claims of the
Internal Revenue Service and criminal claims, if any) will be settled through a
government settlement with the Company and Ventas which will be effectuated
through the Amended Plan.
Under the Government Settlement, the Company will pay the Government a total
of $25.9 million, which will be paid as follows:
(1) $10 million on the effective date of the Amended Plan, and
(2) an aggregate of $15.9 million during the first two full fiscal
quarters following the effective date, plus accrued interest at the rate of
6% per annum beginning as of the effective date of the Amended Plan.
Under the Government Settlement, Ventas will pay the Government a total of
$103.6 million, which will be paid as follows:
(1) $34 million on the effective date of the Amended Plan, and
(2) the remainder paid over five years, bearing interest at the rate of
6% per annum beginning as of the effective date of the Amended Plan.
In addition, the Company will repay the remaining balance of the obligations
under the HCFA Agreement (approximately $63.4 million as of December 31, 2000)
pursuant to the terms previously agreed to by the Company. As previously
announced, the Company has entered into a Corporate Integrity Agreement with
the OIG as part of the overall Government Settlement. The Government Settlement
also provides for the dismissal of certain pending claims and lawsuits filed
against the Company. See Note 20.
General Unsecured Creditors Claims--The general unsecured creditors of the
Company will be paid the full amount of their allowed claims existing as of the
date of the Company's filing for protection under the Bankruptcy Code. These
amounts will be paid in equal quarterly installments over three years beginning
at the end of the first full fiscal quarter following the effective date. The
Company will pay interest on these claims at the rate of 6% per annum from the
effective date of the Amended Plan, subject to certain exceptions. A
convenience class of unsecured creditors, consisting of creditors holding
allowed claims in an amount less than or equal to $3,000, will be paid in full
within 30 days of the effective date of the Amended Plan.
F-46
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 21--COURT APPROVAL OF PLAN OF REORGANIZATION (Continued)
Amended Plan of Reorganization (Continued)
Preferred Stockholder and Common Stockholder Claims--The holders of preferred
stock and common stock of the Company will not receive any distributions under
the Amended Plan. The preferred stock and common stock will be canceled on the
effective date of the Amended Plan.
NOTE 22--EMERGENCE FROM PROCEEDINGS UNDER CHAPTER 11
On April 20, 2001, the Company and its subsidiaries emerged from proceedings
under the Bankruptcy Code pursuant to the terms of the Amended Plan described
in Note 21.
On the date of emergence, the Company entered into a five-year $120 million
senior revolving credit facility (including a $40 million letter of credit
subfacility) with a lending group led by Morgan Guaranty Trust Company of New
York (the "Credit Facility"). The Credit Facility constitutes a working capital
facility for general corporate purposes including payments related to the
Company's obligations under the Amended Plan. Direct borrowings under the
Credit Facility will bear interest, at the option of the Company, at (a) prime
(or, if higher, the federal funds rate plus 1/2%) plus 3% or (b) one, two,
three or six month LIBOR plus 4%. The Credit Facility is collateralized by
substantially all of the assets of the Company and its subsidiaries, including
certain owned real property.
F-47
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
(In thousands, except per share amounts)
2000
---------------------------------------
First Second Third Fourth
-------- -------- -------- ---------
Revenues........................... $715,456 $713,424 $717,253 $ 742,409
Net loss (restated)................ (18,564) (7,985) (29,357) (8,845)
Loss per common share (restated):
Basic............................ (0.27) (0.12) (0.42) (0.13)
Diluted.......................... (0.27) (0.12) (0.42) (0.13)
Market prices (a):
High........................... 0.24 0.13 0.13 0.09
Low............................ 0.11 0.07 0.07 0.03
1999
---------------------------------------
First Second Third Fourth
-------- -------- -------- ---------
Revenues........................... $700,232 $688,892 $681,924 $ 594,593
Net loss (restated):
Loss from operations (b)......... (20,224) (46,085) (47,996) (591,159)(c)
Cumulative effect of change in
accounting for start-up costs... (8,923) - - -
Net loss....................... (29,147) (46,085) (47,996) (591,159)
Loss per common share (restated):
Basic:
Loss from operations............ (0.29) (0.66) (0.69) (8.39)
Cumulative effect of change in
accounting for start-up costs.. (0.13) - - -
Net loss....................... (0.42) (0.66) (0.69) (8.39)
Diluted:
Loss from operations............ (0.29) (0.66) (0.69) (8.39)
Cumulative effect of change in
accounting for start-up costs.. (0.13) - - -
Net loss....................... (0.42) (0.66) (0.69) (8.39)
Market prices (a):
High........................... 5.00 1.13 0.26 0.27
Low............................ 0.81 0.13 0.06 0.07
--------
(a) Vencor common stock is traded on the OTC Bulletin Board under the ticker
symbol of VCRIQ (formerly VCRI). The Company's common stock was delisted
from the New York Stock Exchange on June 7, 1999.
(b) Includes the effect of certain unusual transactions and a charge to
establish a deferred tax valuation allowance. See Notes 6 and 9 of the
Notes to Consolidated Financial Statements for a description of these
transactions.
(c) Includes certain year-end adjustments. See Note 7 of the Notes to
Consolidated Financial Statements for a description of these adjustments.
F-48
KINDRED HEALTHCARE, INC.
(Formerly Vencor, Inc., a Debtor-in-Possession)
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(In thousands)
Additions
-------------------------
Balance at Charged to Balance
Beginning Costs and Deductions at End
of Period Expenses Acquisitions or Payments of Period
---------- ---------- ------------ ----------- ---------
Allowances for loss on
accounts receivable:
Year ended December
31, 1998............. $ 57,023 $ 64,008(a) $ - $(14,560) $106,471
Year ended December
31, 1999............. 106,471 114,578 - (40,994) 180,055
Year ended December
31, 2000............. 180,055 28,911 - (69,521) 139,445
Allowances for loss on
assets held for
disposition:
Year ended December
31, 1998............. 31,422 64,676(b) - (18,172) 77,926
Year ended December
31, 1999............. 77,926 10,135(c) - (13,245) 74,816
Year ended December
31, 2000............. 74,816 2,405 - (52,377) 24,844
--------
(a) Includes unusual charges of $8.4 million.
(b) Reflects provision for loss associated with the sale or closure of home
health and hospice operations, planned disposal of canceled construction
projects and corporate office properties, and closure of two hospitals.
(c) Included in unusual transactions related to corporate properties.
F-49