<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______.
Commission file number 001-14057
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 NO.)
ONE VENCOR PLACE
680 SOUTH FOURTH STREET
LOUISVILLE, KY 40202-2412
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(502) 596-7300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
-------- -------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF COMMON STOCK OUTSTANDING AT OCTOBER 31, 2000
--------------------- -------------------------------
Common stock, $0.25 par value 70,261,693 shares
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1 of 47
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION PAGE
----
<S> <C> <C>
Item 1. Financial Statements:
Condensed Consolidated Statement of Operations -- for the quarter and nine months
ended September 30, 2000 and 1999.................................................. 3
Condensed Consolidated Balance Sheet -- September 30, 2000 and December 31, 1999..... 4
Condensed Consolidated Statement of Cash Flows -- for the nine months ended
September 30, 2000 and 1999........................................................ 5
Notes to Condensed Consolidated Financial Statements................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................. 27
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................... 43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 44
Item 6. Exhibits and Reports on Form 8-K..................................................... 45
</TABLE>
2
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE QUARTER AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
QUARTER NINE MONTHS
-------------------- -------------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues............................................ $717,253 $681,924 $2,146,133 $2,071,048
-------- -------- ---------- ----------
Salaries, wages and benefits........................ 405,510 393,535 1,203,206 1,190,177
Supplies............................................ 92,251 81,484 280,268 252,280
Rent................................................ 77,870 77,423 230,878 228,963
Other operating expenses............................ 132,552 116,948 372,325 353,144
Depreciation and amortization....................... 17,464 24,126 53,534 68,023
Interest expense.................................... 14,415 26,030 45,317 65,598
Investment income................................... (1,490) (673) (3,708) (1,946)
-------- -------- ---------- ----------
738,572 718,873 2,181,820 2,156,239
-------- -------- ---------- ----------
Loss before reorganization costs and income taxes... (21,319) (36,949) (35,687) (85,191)
Reorganization costs................................ 4,745 5,443 10,340 12,302
-------- -------- ---------- ----------
Loss before income taxes............................ (26,064) (42,392) (46,027) (97,493)
Provision for income taxes.......................... 500 50 1,500 150
-------- -------- ---------- ----------
Loss from operations................................ (26,564) (42,442) (47,527) (97,643)
Cumulative effect of change in accounting
for start-up costs............................... - - - (8,923)
-------- -------- ---------- ----------
Net loss................................ (26,564) (42,442) (47,527) (106,566)
Preferred stock dividend requirements............... (261) (261) (784) (784)
-------- -------- ---------- ----------
Loss to common stockholders............. $(26,825) $(42,703) $ (48,311) $ (107,350)
======== ======== ========== ==========
Loss per common share:
Basic:
Loss from operations.......................... $ (0.38) $ (0.61) $ (0.69) $ (1.40)
Cumulative effect of change in accounting
for start-up costs......................... - - - (0.13)
-------- -------- ---------- ----------
Net loss................................ $ (0.38) $ (0.61) $ (0.69) $ (1.53)
======== ======== ========== ==========
Diluted:
Loss from operations.......................... $ (0.38) $ (0.61) $ (0.69) $ (1.40)
Cumulative effect of change in accounting
for start-up costs......................... - - - (0.13)
-------- -------- ---------- ----------
Net loss................................ $ (0.38) $ (0.61) $ (0.69) $ (1.53)
======== ======== ========== ==========
Shares used in computing loss per common share:
Basic............................................ 70,265 70,438 70,217 70,386
Diluted.......................................... 70,265 70,438 70,217 70,386
</TABLE>
See accompanying notes.
3
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 203,947 $ 148,350
Accounts receivable less allowance for loss.............................. 292,654 324,135
Inventories.............................................................. 28,869 28,956
Insurance subsidiary investments......................................... 50,483 16,483
Income taxes............................................................. 6,553 8,884
Other.................................................................... 83,745 65,076
----------- -----------
666,251 591,884
Property and equipment, at cost........................................... 645,874 615,160
Accumulated depreciation.................................................. (286,146) (243,526)
----------- -----------
359,728 371,634
Goodwill less accumulated amortization.................................... 165,061 173,818
Investment in affiliates.................................................. 6,982 15,874
Assets held for sale...................................................... 7,450 17,217
Other..................................................................... 57,673 65,547
----------- -----------
$ 1,263,145 $ 1,235,974
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable......................................................... $ 102,726 $ 101,219
Salaries, wages and other compensation................................... 156,887 159,482
Due to third party payors................................................ 34,736 52,205
Other accrued liabilities................................................ 100,334 83,967
----------- -----------
394,683 396,873
Deferred credits and other liabilities.................................... 72,696 56,250
Liabilities subject to compromise......................................... 1,220,577 1,159,417
Series A preferred stock (subject to compromise).......................... 1,743 1,743
Stockholders' equity (deficit):
Common stock, $0.25 par value; authorized 180,000 shares;
issued 70,265 shares -- September 30 and 70,278 shares -- December 31... 17,566 17,570
Capital in excess of par value........................................... 667,148 667,078
Accumulated deficit...................................................... (1,111,268) (1,062,957)
----------- -----------
(426,554) (378,309)
----------- -----------
$ 1,263,145 $ 1,235,974
=========== ===========
</TABLE>
See accompanying notes.
4
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
2000 1999
-------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss.......................................................................... $(47,527) $(106,566)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization.................................................. 53,534 68,023
Provision for doubtful accounts................................................ 23,496 23,515
Unusual transactions........................................................... 4,701 20,827
Reorganization costs........................................................... 10,340 12,302
Cumulative effect of change in accounting for start-up costs................... - 8,923
Other.......................................................................... 11,711 1,926
Changes in operating assets and liabilities:
Accounts receivable......................................................... 13,479 15,940
Inventories and other assets................................................ (9,481) 11,517
Accounts payable............................................................ 7,833 12,376
Income taxes................................................................ 2,331 3,818
Due to third party payors................................................... (12,687) 54,648
Other accrued liabilities................................................... 97,004 39,252
-------- ---------
Net cash provided by operating activities before reorganization costs.... 154,734 166,501
Payment of reorganization costs................................................... (5,806) (12,267)
-------- ---------
Net cash provided by operating activities................................ 148,928 154,234
-------- ---------
Cash flows from investing activities:
Purchase of property and equipment................................................ (42,445) (72,629)
Sale of assets.................................................................... 15,161 9,400
Surety bond deposits.............................................................. (4,647) (16,763)
Net change in investments......................................................... (34,932) 6,377
Collection of notes receivable.................................................... 1,469 -
Other............................................................................. 100 (3,688)
-------- ---------
Net cash used in investing activities.................................... (65,294) (77,303)
-------- ---------
Cash flows from financing activities:
Net change in lines of credit..................................................... - 55,000
Repayment of long-term debt....................................................... (14,336) (22,446)
Payment of debtor-in-possession deferred financing costs.......................... (800) (3,688)
Payment of deferred financing costs............................................... - (2,068)
Other............................................................................. (12,901) (36,935)
-------- ---------
Net cash used in financing activities.................................... (28,037) (10,137)
-------- ---------
Change in cash and cash equivalents.................................................. 55,597 66,794
Cash and cash equivalents at beginning of period..................................... 148,350 34,551
-------- ---------
Cash and cash equivalents at end of period........................................... $203,947 $ 101,345
======== =========
Supplemental information:
Interest payments................................................................... $ 8,539 $ 34,193
Income tax refunds.................................................................. 606 3,668
</TABLE>
See accompanying notes.
5
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
Vencor, Inc. ("Vencor" or the "Company") provides long-term healthcare
services primarily through the operation of nursing centers and hospitals. At
September 30, 2000, the Company's health services division operated 317 nursing
centers (40,535 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 unaudited condensed consolidated financial statements of the
Company have been prepared in accordance with the American Institute of
Certified Public Accountants Statement of Position 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7") and generally
accepted accounting principles applicable to a going concern, which assumes that
assets will be realized and liabilities will be discharged in the normal course
of business. The unaudited condensed 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 continued 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, (i) the Company's ability to comply with the terms of
the DIP Financing (as defined), (ii) confirmation of a plan of reorganization
under the Bankruptcy Code, (iii) the Company's ability to achieve profitable
operations after such confirmation, and (iv) the Company's ability to generate
sufficient cash from operations to meet its obligations. The proposed plan of
reorganization submitted by the Company and other actions during the Chapter 11
Cases could change materially the amounts currently recorded in the unaudited
condensed consolidated financial statements. See Note 3.
On May 1, 1998, Ventas, Inc. ("Ventas") (formerly known as Vencor, Inc.)
completed the spin-off (the "Spin-off") of its healthcare operations to its
stockholders through the distribution of Vencor common stock. Ventas retained
ownership of substantially all of its real property and leases such real
property to the Company pursuant to 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 historical financial statements of the
Company upon consummation of 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.
The Company regularly reviews the carrying value of certain long-lived assets
in accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" ("SFAS 121"). 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. Operating results for the third
quarter and nine months ended September 30, 2000 include asset impairment
charges of $1.0 million and $6.6 million, respectively.
The accompanying unaudited condensed consolidated financial statements do not
include all of the disclosures normally required by generally accepted
accounting principles or those normally required in annual reports on Form 10-K.
Accordingly, these statements should be read in conjunction with the audited
consolidated financial statements of the Company for the year ended December 31,
1999 filed with the Securities and Exchange Commission on Form 10-K.
6
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION (CONTINUED)
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the Company's customary accounting practices
and the provisions of SOP 90-7. Management believes that the financial
information included herein reflects all adjustments necessary for a fair
presentation of interim results and, except for the transactions described in
Notes 2, 5 and 6, all such adjustments are of a normal and recurring nature.
In the fourth quarter of 1999, the Company realigned its Vencare ancillary
services business. Vencare's rehabilitation, speech and occupational therapy
businesses 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. The accompanying unaudited condensed consolidated financial
statements reflect the realignment of the former Vencare business for all
periods presented.
Effective January 1, 2000, the Company adopted an amortization period of 20
years from the date of acquisition for goodwill. Prior thereto, the Company
generally amortized such costs over 40 years.
Certain prior period amounts have been reclassified to conform with the
current period presentation.
NOTE 2 -- ACCOUNTING CHANGE
Effective January 1, 1999, the Company adopted the provisions of the American
Institute of Certified Public Accountants Statement of Position 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 change in accounting
principle in the first quarter of 1999.
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.
Proposed Plan of Reorganization
On September 29, 2000, the Company filed its plan of reorganization (the
"Proposed Plan") with the Bankruptcy Court. The Proposed Plan represents a step
toward finalizing a consensual arrangement among 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 Department
of Health and Human Services' Office of the Inspector General acting on behalf
of the United States government (the "Government") and the advisors to the
official committee of unsecured creditors. The Bankruptcy Court previously had
extended the Company's exclusive right to submit a plan of reorganization
through September 29, 2000.
7
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Proposed Plan of Reorganization (Continued)
The Company is continuing its negotiations with Ventas regarding the
treatment to be provided to Ventas in the Proposed Plan. The Company believes,
however, that it has substantially completed the negotiation of the broad
economic terms of the amended master lease agreements with Ventas. The Proposed
Plan incorporates these terms and compromise positions to the remaining
unresolved issues between the Company and Ventas. The Company also is
continuing to work with the Government to finalize the precise terms of its
settlement. The economic terms of the Company's settlement with the Government
have been agreed upon as well as the precise language of a Corporate Integrity
Agreement (as defined) that will take effect upon the Company's emergence from
bankruptcy.
In addition to the factors noted herein, confirmation and consummation of the
Proposed Plan are subject to a number of material conditions including, without
limitation, the receipt of the requisite acceptances from various creditor
classes to confirm the Proposed Plan and the Bankruptcy Court's determination
that the Proposed Plan satisfies the statutory requirements for confirmation
under the Bankruptcy Code. There can be no assurance that the Proposed Plan as
submitted will be confirmed or consummated.
The following is a summary of certain material provisions of the Proposed
Plan. The summary does not purport to be complete and is qualified in its
entirety by reference to all of the provisions of the Proposed Plan, including
all exhibits and documents described therein, as filed with the Bankruptcy Court
and as may otherwise be amended and/or supplemented.
The Proposed Plan would provide for, among other things, the following
distributions:
Senior Lender Claims - The Senior Lenders would 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 Subordinated Secured Notes"). The interest on the New
Senior Subordinated Secured Notes would begin to accrue after the first two
fiscal quarters following the effective date of the Proposed Plan and, in lieu
of interest payments, the Company would pay a $25.9 million obligation under the
Government Settlement (as defined) in the first two fiscal quarters following
the effective date of the Proposed Plan, as described below. In addition,
holders of the Senior Lender claims would receive an aggregate distribution of
65.5% 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 Proposed 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") would receive, in the
aggregate, 24.5% of the New Common Stock (subject to dilution from stock
issuances occurring after the effective date of the Proposed Plan). In addition,
the holders of the Subordinated Noteholder Claims would 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 would consist
of warrants to purchase 2,000,000 shares at a price per share equal to an
assumed $450 million aggregate equity value of the Company, and warrants to
purchase 5,000,000 shares at a price per share equal to an assumed $500 million
aggregate equity value.
8
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Proposed Plan of Reorganization (Continued)
Ventas Claim - Ventas would receive the following treatment under the
Proposed Plan:
Four new master leases with Ventas will be assumed as amended, and will
replace the original Master Lease Agreements (as defined) as of the effective
date of the Proposed Plan (the "Amended Leases"). The principal economic terms
of the Amended Leases are as follows:
(a) 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 effective date of the Proposed Plan.
(b) A 2% annual cash escalator in the aggregate minimum rent (beginning on
May 1, 2001), and a 1.5% annual accrued rent escalator (with an interest accrual
at 6% per annum), which would become payable in cash and converted to a cash
escalator on a prospective basis upon the repayment or refinancing of the New
Senior Subordinated Secured Notes.
(c) A one-time option, that can be exercised by Ventas 5 1/2 years after the
effective date of the Proposed Plan, to reset the aggregate minimum rent under
the Amended Leases to the then current fair market rental in exchange for a
payment of $5 million to the Company.
(d) Under the Amended Leases, the "Event of Default" provisions also would be
substantially modified.
In addition to the Amended Leases, Ventas would receive a distribution of 10%
of the New Common Stock (subject to dilution from stock issuances occurring
after the effective date of the Proposed Plan).
Ventas also would enter into a tax escrow agreement with the Company that
provides for the escrow of a $26 million Federal income tax refund received in
2000 and certain other Federal and state income taxes until the expiration of
the applicable statutes of limitation for the auditing of the refunds. The
escrowed funds would be available for payment of certain tax deficiencies, if
any, during the escrow period. At the end of the escrow period, the Company
would be entitled to 100% of the proceeds in the escrow account.
All other agreements between the Company and Ventas, except those modified by
the Proposed Plan, would be assumed by the Company as of the effective date of
the Proposed Plan.
United States Claim - Subject to obtaining applicable government approvals,
the claims of the Government (other than claims of the Internal Revenue Service
and non-monetary criminal claims, if any) would be settled under an agreement
entered into with the Company and Ventas which would be incorporated into the
Proposed Plan (the "Government Settlement"). Under the Government Settlement,
the Company would pay the Government a total of $25.9 million, which would be
paid as follows: (i) $10 million on the effective date of the Proposed Plan and
(ii) an aggregate of $15.9 million during the first two fiscal quarters
following the effective date, plus accrued interest at the rate of 6% per annum
beginning as of the effective date of the Proposed Plan. Ventas would pay the
Government a total of $103.6 million, which would be paid as follows: (i) $34
million on the effective date of the Proposed Plan and (ii) the remainder paid
over five years, bearing interest at the rate of 6% per annum beginning as of
the effective date of the Proposed Plan. In addition, the Company would repay
the remaining balance of the
9
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Proposed Plan of Reorganization (Continued)
obligations under the HCFA Agreement (as defined) (approximately $67.5 million
as of September 30, 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 (the "Corporate
Integrity Agreement") with the Department of Health and Human Services' Office
of the Inspector General ("OIG") as part of the overall Government Settlement.
Under the Corporate Integrity Agreement, the Company will implement a
comprehensive internal quality improvement program in its nursing centers and
long-term hospitals and its regional and corporate offices. As part of the
Corporate Integrity Agreement, the Company will retain staff at the University
of Wisconsin's Center for Health Services Research and Analysis ("CHSRA"), to
assist in developing an 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 must be approved by the Bankruptcy Court and
would become effective concurrent with the Company's emergence from Chapter 11.
General Unsecured Creditors Claims - The general unsecured creditors of the
Company would 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 would be paid in equal quarterly installments over three years with
interest at the rate of 6% per annum from the effective date of the Proposed
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 an amount to be established by the Company, would be paid in full on
the effective date of the Proposed Plan.
Preferred Stockholder and Common Stockholder Claims - The holders of
preferred stock and common stock of the Company would not receive any
distributions under the Proposed Plan. The preferred stock and common stock
would be cancelled on the effective date of the Proposed Plan.
Other Significant Provisions - The board of directors of the reorganized
Company would consist of: (i) Edward L. Kuntz; (ii) four directors selected by
the holders of the claims of the Senior Lenders; and (iii) two directors
selected by the holders of the Subordinated Noteholder Claims.
A performance share plan would be approved under the Proposed Plan that
provides for the distribution of 600,000 shares of New Common Stock to certain
key employees of the Company. The shares would be distributed to participants
in three installments based upon the Company's achievement of certain aggregate
equity values. In addition, a new stock option plan would be approved under the
Proposed 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 Proposed Plan also
would provide for the continuation of the Company's current retention plan for
its key employees and the payment of certain performance bonuses upon the
effective date of the Proposed Plan.
Ventas has announced that it does not support the Proposed Plan and that it
will require changes on substantive issues before Ventas will support the
Proposed Plan.
10
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Proposed Plan of Reorganization (Continued)
First Amendment to Proposed Plan - On or about November 6, 2000, the Company
filed its first amended plan of reorganization (the "Amended Plan") with the
Bankruptcy Court. The Company also filed a first amended disclosure statement
and a short-form disclosure statement (the "Disclosure Materials"), which, if
approved by the Bankruptcy Court, will be used to solicit acceptances of the
Amended Plan. The Company intends to seek approval of the Disclosure Materials
at a hearing before the Bankruptcy Court on December 6, 2000. The Amended Plan
amends the Proposed Plan by including the terms of the Government Settlement,
which Government Settlement remains subject to appropriate governmental approval
and resolution of certain issues including the scope of releases being provided
in conjunction with the Government Settlement.
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 the prime rate plus 2 1/2% on the
Tranche A Loan and the prime rate 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, $70 million in November 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. 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 September 30,
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 (i) extending the period of time for the Company to file its
plan of reorganization, (ii) approving certain transactions, (iii) revising the
Company's cash plan originally submitted with the DIP Financing and (iv)
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 January 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 a plan
of reorganization and disclosure statement and an appropriate motion requesting
confirmation and consummation thereof to November 22, 2000.
At December 31, 1999, the Company was not in compliance with the DIP
Financing covenant related to the minimum Net Amount of Eligible Accounts
(accounts receivable). Since there were no outstanding borrowings under the DIP
Financing at December 31, 1999, the event of default had no effect on the
Company's 1999 consolidated financial statements. Effective April 12, 2000, the
Company and the DIP Lenders agreed to an
11
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Debtor-in-Possession Financing Agreement (Continued)
amendment to the DIP Financing to revise the covenant related to the minimum Net
Amount of Eligible Accounts. In that amendment, the DIP Lenders also waived all
events of default regarding this covenant that occurred prior to the date of the
amendment.
On June 12, 2000, the Company entered into a commitment letter (the
"Commitment Letter") with certain of the DIP Lenders to finance an amended and
restated debtor-in-possession credit agreement in an aggregate principal amount
of $90 million (the "Restated DIP"). The Restated DIP would become effective in
the event the Company became involved in a legal proceeding against Ventas. The
Commitment Letter was initially scheduled to expire on August 31, 2000 unless
the Company obtained Bankruptcy Court approval of the Commitment Letter and paid
all fees payable upon such approval. On August 31, 2000, the Company and the
certain DIP Lenders agreed to an amendment to extend the date by which
Bankruptcy Court approval must be obtained through October 31, 2000. On October
23, 2000, the Company and the certain DIP Lenders agreed to a further amendment
to extend the date for Bankruptcy Court approval to January 31, 2001. The
Bankruptcy Court approved this latest amendment to the Commitment Letter on
October 25, 2000. The consummation of the Restated DIP also would be subject to
other customary conditions contained in the Commitment Letter. At this time,
the Company has adjourned the hearing seeking approval of the Commitment Letter
and the Restated DIP in light of the status of the current negotiations with its
major constituencies to finalize the terms of the Proposed Plan.
Events Leading to Reorganization
The Company reported a net loss from operations in 1998 aggregating $573
million, resulting in certain financial covenant violations under the Company's
$1.0 billion bank credit facility (the "Credit Agreement"). Namely, the
covenants regarding minimum net worth, total leverage ratio, senior leverage
ratio and fixed charge coverage ratio were not satisfied at December 31, 1998.
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 by April
23, 1999. 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 accrues 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 $67.5 million at September 30, 2000 and have been
classified as liabilities subject to compromise in the Company's unaudited
condensed 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 1998 Notes. The failure to pay interest
resulted in an event of default under the 1998 Notes.
12
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Events Leading to Reorganization (Continued)
In accordance with SOP 90-7, outstanding borrowings under the Credit
Agreement ($509.1 million) and the principal amount of the 1998 Notes ($300
million) are presented as liabilities subject to compromise in the Company's
unaudited condensed consolidated balance sheet at September 30, 2000. If the
Chapter 11 Cases had not been filed, the Company would have reported a working
capital deficit approximating $900 million at September 30, 2000. The unaudited
condensed 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 not
accrued for the 1998 Notes during the third quarter and the nine months ended
September 30, 2000 were $7.4 million and $22.2 million, respectively.
As previously reported, the Company was informed by the 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. The Company has cooperated fully in these
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. See Note
10. The Company believes that the DOJ's intervention in these actions will
facilitate the ability of the parties to reach a final resolution. The Company
and Ventas are continuing settlement discussions with the DOJ to finalize the
Government Settlement to resolve all of the DOJ investigations including the
pending qui tam actions.
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"). On March 31, 1999, the Company and Ventas entered into a
standstill agreement (the "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 agreement (the "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.
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
(the "Tolling Agreement").
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.
13
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Agreements with Ventas (Continued)
In connection with the Chapter 11 Cases, the Company and Ventas entered into
a stipulation (the "Stipulation") which provides for the payment by the Company
of a reduced monthly rent of approximately $15.1 million beginning in September
1999. The Stipulation was approved by the Bankruptcy Court. The difference
between the $19.3 million base rent under the Master Lease Agreements and the
reduced monthly rent is being accrued as an administrative expense subject to
compromise in the Chapter 11 Cases. Unpaid August 1999 rent of approximately
$18.9 million, constituting a claim by Ventas in the Chapter 11 Cases, is
potentially subject to dispute.
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.
If the Company and Ventas are unable to 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
(i) 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 (ii) 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.
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"). In connection with the Spin-off, the Company and Ventas entered
into a tax allocation agreement under which Ventas agreed that the Company would
be entitled to any tax refunds associated with its former healthcare operations.
In February 2000, a Federal tax refund in excess of $26 million was received by
Ventas. The Company has asserted that it is entitled to the refund under
several grounds, including the terms of the existing tax allocation agreement.
Accordingly, the Company demanded that Ventas enter into the Tax Stipulation
which provides that certain refunds of Federal, state and local taxes received
by either party on or after September 13, 1999 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.
14
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
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 unaudited condensed 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.
On November 4, 1999, the Company received approval (subject to certain
conditions) to implement a management retention plan (the "Management Retention
Plan") to enhance the ability of the Company to retain key management employees
during the reorganization period. Under the Management Retention Plan, bonuses
aggregating $7.3 million will be awarded to certain key management employees
based upon various percentages of their annual salary. The Management Retention
Plan provides that the retention bonuses be paid in three equal amounts upon:
(i) the Bankruptcy Court's approval of the Management Retention Plan, (ii) the
effective date of a plan of reorganization and (iii) three months following the
effective date of a plan of reorganization.
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.
A substantial portion of pre-petition liabilities are subject to settlement
under the Proposed Plan submitted by the Company. The Proposed Plan must be
voted upon by certain of the impaired creditors of the Company and approved by
the Bankruptcy Court. There can be no assurance that the Proposed Plan submitted
by the Company will be approved by the requisite holders of claims, confirmed by
the Bankruptcy Court or that it will be consummated. If the Proposed Plan is not
accepted by the required number of impaired creditors and the Company's
exclusive right to file and solicit acceptance of the Proposed Plan ends, any
party in interest may subsequently file its own plan of reorganization for the
Company.
A plan of reorganization must be confirmed by the Bankruptcy Court after
certain findings required by the Bankruptcy Code are made by the Bankruptcy
Court. The Bankruptcy Court may confirm a plan of reorganization notwithstanding
the non-acceptance of the plan by an impaired class of creditors or equity
holders if certain requirements of the Bankruptcy Code are satisfied.
15
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 3 -- PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE (CONTINUED)
Liabilities Subject to Compromise
"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, treatment under a confirmed plan of reorganization and other
events. Proposed payment terms for these amounts are set forth in the Proposed
Plan.
All pre-petition liabilities, other than those for which the Company has
received Bankruptcy Court approval to pay, are classified in the unaudited
condensed 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):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------- -------------
<S> <C> <C>
Long-term debt:
Credit Agreement....................... $ 509,143 $ 506,114
1998 Notes............................. 300,000 300,000
Amounts due under the HCFA Agreement... 67,469 80,296
8 5/8% Senior Subordinated Notes....... 2,391 2,391
Unamortized deferred financing costs... (10,883) (12,626)
Other.................................. 3,185 4,592
---------- ----------
871,305 880,767
---------- ----------
Due to third party payors............... 117,477 112,694
Accounts payable........................ 31,177 33,693
Accrued liabilities:
Interest............................... 78,959 45,521
Ventas rent............................ 69,519 33,884
Other.................................. 52,140 52,858
---------- ----------
200,618 132,263
---------- ----------
$1,220,577 $1,159,417
========== ==========
</TABLE>
Substantially all of the liabilities subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.
16
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4 -- REVENUES
Revenues are recorded based upon estimated amounts due from patients and
third party payors for the provision of healthcare services, including
anticipated settlements under reimbursement agreements with Medicare, Medicaid
and other third party payors.
A summary of revenues by payor type follows (in thousands):
<TABLE>
<CAPTION>
QUARTER NINE MONTHS
--------------------- -------------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Medicare............ $253,054 $225,483 $ 765,988 $ 719,451
Medicaid............ 238,783 237,403 681,858 680,785
Private and other... 239,095 233,205 740,926 716,694
-------- -------- ---------- ----------
730,932 696,091 2,188,772 2,116,930
Elimination......... (13,679) (14,167) (42,639) (45,882)
-------- -------- ---------- ----------
$717,253 $681,924 $2,146,133 $2,071,048
======== ======== ========== ==========
</TABLE>
NOTE 5 -- UNUSUAL TRANSACTIONS
Operating results for each period presented include certain unusual
transactions. These transactions are included in other operating expenses in
the unaudited condensed consolidated statement of operations for the respective
periods in which they were recorded.
In the third quarter of 2000, the Company recorded a $9.2 million write-off
of an impaired investment. Operating results for the nine months ended
September 30, 2000 also included a $4.5 million gain on the sale of a closed
hospital. Operating results for the nine months ended September 30, 1999
included a $15.2 million write-off of the Company's remaining investment in a
healthcare related entity and a $5.6 million charge for the cancellation of a
nursing center software development project.
NOTE 6 -- REORGANIZATION COSTS
Reorganization costs, consisting principally of professional fees, aggregated
$4.7 million and $5.4 million in the third quarters of 2000 and 1999,
respectively, and $10.3 million and $12.3 million for the respective nine month
periods.
NOTE 7 -- EARNINGS PER SHARE
Basic and diluted earnings per common share are based upon the weighted
average number of common shares outstanding. No incremental shares were
included in the calculations of the diluted loss per common share since the
results would be antidilutive.
17
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 8 -- BUSINESS SEGMENT DATA
The Company operates two business segments: the health services division and
the hospital division. The health services division operates nursing centers
and a rehabilitation therapy business. The hospital division operates hospitals
and an institutional pharmacy business. The Company defines operating income as
earnings before interest, income taxes, depreciation, amortization and rent.
Operating income reported for each of the Company's business segments excludes
allocations of corporate overhead.
The following table sets forth the Company's revenues, operating results and
assets by business segment (in thousands):
<TABLE>
<CAPTION>
QUARTER NINE MONTHS
--------------------- -------------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues:
Health services division:
Nursing centers............................................ $420,588 $399,907 $1,246,450 $1,196,211
Rehabilitation services.................................... 34,032 46,088 101,582 150,687
Other ancillary services................................... (1) 10,477 (8) 39,595
Elimination................................................ (19,671) (31,770) (56,271) (100,539)
-------- -------- ---------- ----------
434,948 424,702 1,291,753 1,285,954
Hospital division:
Hospitals.................................................. 244,391 230,682 748,009 704,072
Pharmacy................................................... 51,593 40,707 149,010 126,904
-------- -------- ---------- ----------
295,984 271,389 897,019 830,976
-------- -------- ---------- ----------
730,932 696,091 2,188,772 2,116,930
Elimination of pharmacy charges to Company nursing centers... (13,679) (14,167) (42,639) (45,882)
-------- -------- ---------- ----------
$717,253 $681,924 $2,146,133 $2,071,048
======== ======== ========== ==========
INCOME (LOSS) FROM OPERATIONS:
Operating income (loss):
Health services division:
Nursing centers.......................................... $ 71,627 $ 55,881 $ 219,955 $ 174,189
Rehabilitation services.................................. 2,841 5,277 2,276 20,607
Other ancillary services................................. 2,687 1,333 3,059 5,964
-------- -------- ---------- ----------
77,155 62,491 225,290 200,760
Hospital division:
Hospitals................................................ 47,915 54,084 156,122 172,151
Pharmacy................................................. 1,094 679 721 8,107
-------- -------- ---------- ----------
49,009 54,763 156,843 180,258
Corporate overhead......................................... (29,988) (27,297) (87,098) (84,744)
Unusual transactions....................................... (9,236) - (4,701) (20,827)
Reorganization costs....................................... (4,745) (5,443) (10,340) (12,302)
-------- -------- ---------- ----------
Operating income..................................... 82,195 84,514 279,994 263,145
Rent......................................................... (77,870) (77,423) (230,878) (228,963)
Depreciation and amortization................................ (17,464) (24,126) (53,534) (68,023)
Interest, net................................................ (12,925) (25,357) (41,609) (63,652)
-------- -------- ---------- ----------
Loss before income taxes..................................... (26,064) (42,392) (46,027) (97,493)
Provision for income taxes................................... 500 50 1,500 150
-------- -------- ---------- ----------
$(26,564) $(42,442) $ (47,527) $ (97,643)
======== ======== ========== ==========
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ -----------------
Assets:
Health services division................................... $ 472,400 $ 489,316
Hospital division.......................................... 314,221 337,218
Corporate.................................................. 476,524 409,440
---------- ----------
$1,263,145 $1,235,974
========== ==========
</TABLE>
18
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 9 -- INCOME TAXES
The provision for income taxes is based upon management's estimate of taxable
income or loss for the year and includes the effect of certain non-deductible
items such as goodwill amortization and the recording of additional deferred tax
valuation allowances.
The provision for income taxes for the third quarter of 2000 and 1999
included charges of $7.3 million and $15.0 million, respectively, related to the
deferred tax valuation allowance. For the nine months ended September 30, 2000
and 1999, charges related to the deferred tax valuation allowance totaled $13.5
million and $26.4 million, respectively. In addition, the Company recorded a
valuation allowance of $3.4 million in the first quarter of 1999 related to the
change in accounting for start-up costs. At September 30, 2000, the deferred
tax valuation allowance included in the Company's unaudited condensed
consolidated balance sheet aggregated $362.8 million.
NOTE 10 -- 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 September 29, 2000, the Company filed its
Proposed Plan with the Bankruptcy Court. 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 the 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 the 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 the
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 which provides for the payment by the Company of a reduced
monthly rent of approximately $15.1 million beginning in September 1999. The
Stipulation was 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.
19
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
If the Company and Ventas are unable to 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 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 terminating the
Master Lease Agreements, repossessing and reletting the leased properties and
requiring the Company to (i) 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 (ii) 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 ("TheraTx"),
is a plaintiff in a declaratory judgment action entitled TheraTx, Incorporated
v. James W. Duncan, Jr., et al., No. 1:95-CV-3193, filed in the United States
District Court for the Northern District of Georgia and currently pending in the
United States Court of Appeals for the Eleventh Circuit, No. 99-11451-FF. The
defendants have asserted counterclaims against TheraTx under breach of contract,
securities fraud, negligent misrepresentation and fraud theories for allegedly
not performing as promised under a merger agreement related to TheraTx's
purchase of a company called PersonaCare, Inc. and for allegedly failing to
inform the defendants/counterclaimants prior to the merger that TheraTx's
possible acquisition of Southern Management Services, Inc. might cause the
suspension of TheraTx's shelf registration under relevant rules of the
Securities and Exchange Commission. The court granted summary judgment for the
defendants/counterclaimants and ruled that TheraTx breached the shelf
registration provision in the merger agreement, but dismissed the defendants'
remaining counterclaims. Additionally, the court ruled after trial that
defendants/counterclaimants were entitled to damages and prejudgment interest in
the amount of approximately $1.3 million and attorneys' fees and other
litigation expenses of approximately $700,000. The Company and the
defendants/counterclaimants both have appealed the court's rulings. 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
20
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
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 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 (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 Hospitals Corporation
("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 Transitional's 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
21
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
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. 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 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 has 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
and intends to defend these actions vigorously. Lenox and its subsidiaries filed
for protection under Chapter 11 of the Bankruptcy Code on November 3, 1999. The
Company has not determined the effect, if any, such filing will have on the
Company's financial condition, results of operations or liquidity. 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 are stayed.
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. 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 and
Ventas are continuing settlement discussions with the DOJ to finalize the
Government Settlement to resolve all of the DOJ investigations including the
pending qui tam actions. For a summary of the terms of the proposed Government
Settlement contained in the Proposed Plan, see Note 3. There can be no
assurance, however, that a settlement or other resolution will be consummated
with the DOJ.
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.
22
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
(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 ("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 and Vencor 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.
23
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
(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
amendments (the "Antikickback Amendments") 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 the Antikickback
Amendments. 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 Amendments. 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
Amendments 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.
24
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
(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 (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.
25
<PAGE>
VENCOR, INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 10 -- LITIGATION (CONTINUED)
(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. Defendant 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.
NOTE 11 -- THIRD PARTY SETTLEMENTS
In January 2000, the Company filed its hospital cost reports for the year
ended August 31, 1999. Cost reports 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 are classified
as liabilities subject to compromise in the unaudited condensed consolidated
balance sheet and, accordingly, no funds were disbursed by the Company in
settlement of such pre-petition liabilities.
26
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
Certain statements made in this Form 10-Q, including, but not limited to,
statements containing the words such as "anticipate," "believe," "plan,"
"estimate," "expect," "intend," "may" and other similar expressions are forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. 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. 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 ability of the Company to continue as a
going concern; the delays or the inability to complete and/or consummate the
Company's Proposed Plan; the ability of the Company to operate pursuant to the
terms of the DIP Financing; the Company's ability to satisfy the conditions to
effectuate the Restated DIP; 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 personnel; the effects of healthcare
reform and legislation on the Company's business strategy and operations; 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 DOJ 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.
GENERAL
The business segment data in Note 8 of the Notes to Condensed Consolidated
Financial Statements should be read in conjunction with the following discussion
and analysis.
The Company provides long-term healthcare services primarily through the
operation of nursing centers and hospitals. At September 30, 2000, the
Company's health services division operated 317 nursing centers (40,535 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.
Vencare Realignment. In the fourth quarter of 1999, the Company realigned
its Vencare ancillary services business. Vencare's rehabilitation, speech and
occupational therapy businesses 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 the
following discussion and analysis reflect the realignment of the former Vencare
business for all periods presented.
27
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
GENERAL (CONTINUED)
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 continued 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, (i) the Company's ability to comply with the terms of
the DIP Financing, (ii) confirmation of the Proposed Plan or other plan of
reorganization submitted by the Company under the Bankruptcy Code, (iii) the
Company's ability to achieve profitable operations after such confirmation, and
(iv) the Company's ability to generate sufficient cash from operations to meet
its obligations. On September 29, 2000, the Company filed its Proposed Plan
with the Bankruptcy Court. The Proposed Plan and other actions during the
Chapter 11 Cases could change materially the amounts currently recorded in the
unaudited condensed consolidated financial statements. See Note 3 of the Notes
to Condensed 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 Vencor pursuant to 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
historical financial statements of the Company upon consummation of 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.
The unaudited condensed consolidated financial statements have been prepared
on the basis of accounting principles applicable to going concerns and
contemplate the realization of assets and settlement of liabilities and
commitments in the normal course of business. The unaudited condensed
consolidated financial statements do not include any adjustments that might
result from the resolution of the Chapter 11 Cases or other matters discussed
herein.
RESULTS OF OPERATIONS
REGULATORY CHANGES
Legislative and regulatory activities in the long-term healthcare industry
have had a significant negative impact on the Company's operating results.
The Balanced Budget Act of 1997 (the "Budget Act"), contained extensive
changes to the Medicare and Medicaid programs intended to reduce the projected
amount of increase in payments under those programs over a five year period.
Virtually all spending reductions 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 a Medicare prospective payment system ("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.
28
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
REGULATORY CHANGES (CONTINUED)
In November 1999, the Balanced Budget Refinement Act (the "BBRA") was enacted
to provide a measure of relief for some of the impact of PPS. 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. Effective October 1,
2000, the BBRA adjusted all payment categories up 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 which 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.
Despite the effects of the BBRA and the HCFA ruling discussed above, revenues
recorded under PPS in the Company's health services division are substantially
less than the cost-based reimbursement it received before the enactment of the
Budget Act.
The Budget Act also reduced payments made to the hospitals operated by the
Company's hospital division 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 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 for 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 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 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.
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. 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 a number of legislative proposals including
cost caps and the establishment of Medicaid prospective payment systems for
nursing centers. Moreover, by repealing the Boren Amendment, the Budget Act
eases existing impediments on the states' ability to reduce their Medicaid
reimbursement levels.
29
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
REGULATORY CHANGES (CONTINUED)
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% to $421 million in the third quarter of 2000 and 4% to
$1.25 billion for the nine months ended September 30, 2000 compared to the same
periods a year ago. While patient volumes did not change significantly,
revenues per patient day grew 6% in the third quarter and 4% for the nine month
period ended September 30, 2000 primarily as a result of increased Medicare and
Medicaid funding and price increases to private payors. Medicare revenues per
patient day under PPS were $301 in the third quarter of 2000 compared to $283 in
the third quarter a year ago, and $298 for the nine months ended September 30,
2000 compared to $289 in the prior year. Despite a decline in patient acuity
levels, the increase in Medicare reimbursement rates for both periods resulted
primarily from regulatory changes associated with the BBRA and an increase in
therapy services.
Operating income increased 28% to $72 million in the third quarter and 26% to
$220 million for the nine month period compared to the same periods a year ago.
A substantial portion of the improvement in operating margins in both periods
resulted from operating efficiencies related to the fourth quarter 1999 Vencare
realignment. However, costs related to professional liability risks and doubtful
accounts rose by $7 million and $17 million from the third quarter and first
nine months of 1999, respectively. In the aggregate, operating costs (wages,
benefits, supplies and other expenses) per patient day increased 2% in the third
quarter and were relatively unchanged for the nine month period compared to a
year ago.
HEALTH SERVICES DIVISION - REHABILITATION SERVICES
Revenues declined 26% to $34 million in the third quarter of 2000 and 33% to
$102 million for the nine months ended September 30, 2000 from the respective
periods last year. The decline in revenues was primarily attributable to
continued reductions in the demand for ancillary services in response to fixed
reimbursement rates under PPS. Approximately one-half of the revenue decline in
both periods 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 $3 million and $2
million for the third quarter and nine month period, respectively, compared to
operating income of $5 million and $21 million for the same periods last year.
Operating results in the third quarter of 2000 reflect $3 million of favorable
adjustments for doubtful accounts resulting from collections of past due
accounts. The reduction in operating income reflects a continued decline in
30
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
HEALTH SERVICES DIVISION - REHABILITATION SERVICES (CONTINUED)
customer demand resulting from PPS. 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. 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.
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 the third quarter of 2000
reflect $2 million of favorable adjustments for doubtful accounts resulting from
collections from discontinued customer accounts.
HOSPITAL DIVISION - HOSPITALS
Revenues in both the third quarter and nine months ended September 30, 2000
increased 6% to $244 million and $748 million, respectively. The increase in
both periods was primarily attributable to growth in patient days.
Revenues per patient day remained relatively unchanged in the third quarter
and nine month period compared to the respective periods a year ago. Medicare
revenues recorded by the Company's hospitals in prior years included
reimbursement for expenses related to certain costs associated with hospital-
based ancillary services previously provided by the Vencare division to its
nursing center customers. In connection with the continued settlement
discussions with the DOJ, the Company has agreed to discontinue recording such
revenues and has excluded such costs from its Medicare cost reports since
September 1, 1999. Medicare revenues related to the reimbursement of such costs
aggregated $4 million in the third quarter of 1999 and $18 million for the nine
months ended September 30, 1999.
Hospital operating income declined 11% to $48 million in the third quarter of
2000 and declined 9% to $156 million for the nine months ended September 30,
2000 compared to the same periods a year ago. Despite an increase in patient
days, operating costs per patient day increased 5% in both periods primarily as
a result of growth in labor and pharmaceutical costs. Operating income also was
adversely impacted by the previously discussed reduction in Medicare
reimbursement for hospital-based ancillary services.
HOSPITAL DIVISION - PHARMACY
Revenues increased 27% to $52 million in the third quarter of 2000 and
increased 17% to $149 million for the nine months ended September 30, 2000
compared to the same periods a year ago. The increases resulted primarily from
growth in the number of nursing center customers.
Operating income in the third quarter of both years approximated $1 million.
For the nine months ended September 30, 2000, the pharmacy business reported
operating income of $1 million compared to operating income of $8 million for
the same period of 1999. Operating income during fiscal 2000 was adversely
impacted by pricing pressures associated with PPS and pharmaceutical cost
increases. Supply costs as a percentage of revenues rose to 59% in the third
quarter of 2000 from 52% in 1999 and rose to 62% from 54% for the comparable
nine month periods.
31
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
CORPORATE OVERHEAD
Operating income for the Company's operating divisions excluded allocations
of corporate overhead. These costs aggregated $30 million and $27 million in
the third quarters of 2000 and 1999, respectively, and $87 million and $85
million for the nine months ended September 30, 2000 and 1999, respectively. As
a percentage of revenues (before eliminations), corporate overhead was 4.1% and
3.9% for the respective third quarters of 2000 and 1999, and 4.0% for both of
the respective nine month periods.
UNUSUAL TRANSACTIONS
Operating results for each period presented include certain unusual
transactions. These transactions are included in other operating expenses in
the unaudited condensed consolidated statement of operations for the respective
periods in which they were recorded.
In the third quarter of 2000, the Company recorded a $9 million write-off of
an impaired investment. Operating results for the nine months ended September
30, 2000 also included a $5 million gain on the sale of a closed hospital.
Operating results for the nine months ended September 30, 1999 included a $15
million write-off of the Company's remaining investment in a healthcare related
entity and a $6 million charge for the cancellation of a nursing center software
development project.
CAPITAL COSTS
The Company leases substantially all of its facilities. Depreciation and
amortization, rents and net interest costs aggregated $108 million in the third
quarter of 2000 compared to $127 million for the same period last year and $326
million and $361 million for the nine months ended September 30, 2000 and 1999,
respectively. While rents were relatively unchanged, depreciation and
amortization declined primarily as a result of significant write-offs of
property, equipment and goodwill in the fourth quarter of 1999 in connection
with the Company's valuation of its long-lived assets required by SFAS 121. On
January 1, 2000, the Company changed its goodwill amortization period from 40
years to 20 years from the date of acquisition. The impact of this change was
not material. See Note 1 of the Notes to Condensed Consolidated Financial
Statements.
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 and the rents due to Ventas under the Master Lease Agreements. No
interest costs have been recorded related to the 1998 Notes since the filing of
the Chapter 11 Cases. Contractual interest expense not accrued for the 1998
Notes approximated $7 million and $22 million for the third quarter and first
nine months of 2000, respectively.
INCOME TAXES
The provision for income taxes is based upon management's estimate of taxable
income or loss for the year and includes the effect of certain non-deductible
items such as goodwill amortization and the recording of additional deferred tax
valuation allowances.
The provision for income taxes for the third quarter of 2000 and 1999
included charges of $8 million and $15 million, respectively, related to the
deferred tax valuation allowance. For the nine months ended September 30, 2000
and 1999, charges related to the deferred tax valuation allowance totaled $14
million and $26 million, respectively. In addition, the Company recorded a
valuation allowance of $3 million in the first quarter of 1999 related to the
change in accounting for start-up costs. At September 30, 2000, the deferred
tax valuation allowance included in the Company's unaudited condensed
consolidated balance sheet aggregated $363 million.
32
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS (CONTINUED)
CONSOLIDATED RESULTS
The Company reported a pretax loss from operations before reorganization
costs of $22 million in the third quarter of 2000 compared to $37 million in the
third quarter of 1999. For the nine months ended September 30, 2000, the
Company recorded a pretax loss from operations before reorganization costs of
$36 million compared to $85 million for the same period of 1999.
Reorganization costs, consisting principally of professional fees, aggregated
$4 million and $5 million in the third quarters of 2000 and 1999, respectively,
and $10 million and $12 million for the respective nine month periods.
The net loss from operations in the third quarter of 2000 aggregated $27
million compared to a net loss of $42 million in the third quarter of 1999. For
the nine months ended September 30, 2000, the Company's net loss from operations
totaled $48 million compared to a net loss of $98 million a year ago. In
addition, the Company recorded a $9 million charge in the first quarter of 1999
to reflect the change in accounting for start-up costs. See Note 2 of the Notes
to Condensed Consolidated Financial Statements.
LIQUIDITY
As previously discussed, the Company and substantially all of its
subsidiaries filed voluntary petitions for protection under Chapter 11 of 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
Bankruptcy Court. On September 29, 2000, the Company filed its Proposed Plan
with the Bankruptcy Court. See Note 3 of the Notes to Condensed Consolidated
Financial Statements.
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 unaudited condensed 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, which was initially
scheduled to mature on March 13, 2000, is comprised of the Tranche A Loan and
the Tranche B Loan. Interest is payable at the prime rate plus 2 1/2% on the
Tranche A Loan and the prime rate 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, $70 million in November 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. 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 September 30,
2000, there were no outstanding borrowings under the DIP Financing.
33
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY (CONTINUED)
Since the consummation of the DIP Financing, the Company and the DIP Lenders
have agreed to several amendments to the DIP Financing. These amendments
approved various changes to the DIP Financing including (i) extending the period
of time for the Company to file its plan of reorganization, (ii) approving
certain transactions, (iii) revising the Company's cash plan originally
submitted with the DIP Financing and (iv) 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 January 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 a plan
of reorganization and disclosure statement and an appropriate motion requesting
confirmation and consummation thereof to November 22, 2000.
At December 31, 1999, the Company was not in compliance with the DIP
Financing covenant related to the minimum Net Amount of Eligible Accounts
(accounts receivable). Since there were no outstanding borrowings under the DIP
Financing at December 31, 1999, the event of default had no effect on the
Company's 1999 consolidated financial statements. Effective April 12, 2000, the
Company and the DIP Lenders agreed to an amendment to the DIP Financing to
revise the covenant related to the minimum Net Amount of Eligible Accounts. In
that amendment, the DIP Lenders also waived all events of default regarding this
covenant that occurred prior to the date of the amendment. The Company was in
compliance with the DIP Financing covenants at September 30, 2000.
On June 12, 2000, the Company entered into the Commitment Letter with certain
of the DIP Lenders to finance the Restated DIP. The Restated DIP would become
effective in the event the Company became involved in a legal proceeding against
Ventas. The Commitment Letter was initially scheduled to expire on August 31,
2000 unless the Company obtained Bankruptcy Court approval of the Commitment
Letter and paid all fees payable upon such approval. On August 31, 2000, the
Company and the certain DIP Lenders agreed to an amendment to extend the date by
which Bankruptcy Court approval must be obtained through October 31, 2000. On
October 23, 2000, the Company and the certain DIP Lenders agreed to a further
amendment to extend the date for Bankruptcy Court approval to January 31, 2001.
The Bankruptcy Court approved this latest amendment to the Commitment Letter on
October 25, 2000. The consummation of the Restated DIP also would be subject to
other customary conditions contained in the Commitment Letter. At this time,
the Company has adjourned the hearing seeking approval of the Commitment Letter
and the Restated DIP in light of the status of the current negotiations with its
major constituencies to finalize the terms of the Proposed Plan.
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.
A substantial portion of pre-petition liabilities are subject to settlement
under the Proposed Plan submitted by the Company. The Proposed Plan must be
voted upon by certain of the impaired creditors of the Company and approved by
the Bankruptcy Court. There can be no assurance that the Proposed Plan submitted
by the Company will be approved by the requisite holders of claims, confirmed by
the Bankruptcy Court or that it will be consummated. If the Proposed Plan is not
accepted by the required number of impaired creditors and the Company's
exclusive right to file and solicit acceptance of the Proposed Plan ends, any
party in interest may subsequently file its own plan of reorganization for the
Company.
34
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
LIQUIDITY (CONTINUED)
A plan of reorganization must be confirmed by the Bankruptcy Court after
certain findings required by the Bankruptcy Code are made by the Bankruptcy
Court. The Bankruptcy Court may confirm a plan of reorganization notwithstanding
the non-acceptance of the plan by an impaired class of creditors or equity
holders if certain requirements of the Bankruptcy Code are satisfied.
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 by April 23, 1999. On April 21, 1999, the Company entered into the
HCFA Agreement under which non-interest bearing monthly payments of
approximately $1.5 million commenced in May 1999. Beginning in December 1999,
interest accrues on the balance of the overpayments at a statutory rate
approximating 13.4%, resulting in a monthly payment of approximately $2 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 $67 million at September 30, 2000 and have been classified as
liabilities subject to compromise in the Company's unaudited condensed
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.
LIABILITIES SUBJECT TO COMPROMISE
"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, treatment under a confirmed plan of reorganization and other
events. Proposed payment terms for these amounts are set forth in the Proposed
Plan.
All pre-petition liabilities, other than those for which the Company has
received Bankruptcy Court approval to pay, are classified in the unaudited
condensed consolidated balance sheet as liabilities subject to compromise.
Substantially all of the liabilities subject to compromise would have been
classified as current liabilities if the Chapter 11 Cases had not been filed.
CASH FLOWS
Since the filing of the Chapter 11 Cases, cash flows from operations have
allowed the Company to fund post-petition obligations, sustain adequate
liquidity levels and minimize borrowings under the DIP Financing. Cash flows
from operations before reorganization costs totaled $155 million for the nine
months ended September 30, 2000 compared to $167 million for the nine months
ended September 30, 1999. There can be no assurance, however, that the Company
can maintain its current liquidity levels during the pendency of the Chapter 11
Cases.
In January 2000, the Company filed its hospital cost reports for the year
August 31, 1999. Cost reports 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 are classified as liabilities
subject to compromise in the unaudited condensed consolidated balance sheet and,
accordingly, no funds were disbursed by the Company in settlement of such pre-
petition liabilities.
35
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
CAPITAL RESOURCES
Capital expenditures for the first nine months of 2000 aggregated $42 million
compared to $73 million a year ago. Capital expenditures could approximate $80
million in 2000. Management believes that its capital expenditure program is
adequate to improve and equip existing facilities.
Capital expenditures in both periods were financed through internally
generated funds. At September 30, 2000, the estimated cost to complete and
equip construction in progress approximated $16 million. There can be no
assurance that the Company will have sufficient resources to finance its capital
expenditures program in 2000.
OTHER INFORMATION
The Company is a party to certain material legal actions and regulatory
investigations. See Note 10 of the Notes to Condensed Consolidated Financial
Statements.
36
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
2000 QUARTERS
----------------------------------------
FIRST SECOND THIRD NINE MONTHS
---------- -------------- ---------- ------------
<S> <C> <C> <C> <C>
Revenues.............................................. $715,456 $713,424 $717,253 $2,146,133
-------- -------- -------- ----------
Salaries, wages and benefits.......................... 405,313 392,383 405,510 1,203,206
Supplies.............................................. 93,398 94,619 92,251 280,268
Rent.................................................. 76,220 76,788 77,870 230,878
Other operating expenses.............................. 119,796 119,977 132,552 372,325
Depreciation and amortization......................... 17,902 18,168 17,464 53,534
Interest expense...................................... 16,239 14,663 14,415 45,317
Investment income..................................... (1,206) (1,012) (1,490) (3,708)
-------- -------- -------- ----------
727,662 715,586 738,572 2,181,820
-------- -------- -------- ----------
Loss before reorganization costs and income taxes..... (12,206) (2,162) (21,319) (35,687)
Reorganization costs.................................. 3,065 2,530 4,745 10,340
-------- -------- -------- ----------
Loss before income taxes.............................. (15,271) (4,692) (26,064) (46,027)
Provision for income taxes............................ 500 500 500 1,500
-------- -------- -------- ----------
Net loss........................................... (15,771) (5,192) (26,564) (47,527)
Preferred stock dividend requirements................. (261) (262) (261) (784)
-------- -------- -------- ----------
Loss to common stockholders........................ $(16,032) $ (5,454) $(26,825) $ (48,311)
======== ======== ======== ==========
Net loss per common share:
Basic.............................................. $(0.23) $(0.08) $(0.38) $(0.69)
Diluted............................................ (0.23) (0.08) (0.38) (0.69)
Shares used in computing net loss per common share:
Basic.............................................. 70,240 70,147 70,265 70,217
Diluted............................................ 70,240 70,147 70,265 70,217
</TABLE>
37
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999 QUARTERS
--------------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
---------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenues................................ $700,232 $688,892 $681,924 $ 594,593 $2,665,641
-------- -------- -------- ---------- ----------
Salaries, wages and benefits............ 403,894 392,748 393,535 376,050 1,566,227
Supplies................................ 84,997 85,799 81,484 95,509 347,789
Rent.................................... 75,452 76,088 77,423 76,157 305,120
Other operating expenses................ 107,007 129,189 116,948 589,054 942,198
Depreciation and amortization........... 22,285 21,612 24,126 25,173 93,196
Interest expense........................ 19,536 20,032 26,030 14,844 80,442
Investment income....................... (631) (642) (673) (3,242) (5,188)
-------- -------- -------- ---------- ----------
712,540 724,826 718,873 1,173,545 3,329,784
-------- -------- -------- ---------- ----------
Loss before reorganization costs
and income taxes...................... (12,308) (35,934) (36,949) (578,952) (664,143)
Reorganization costs.................... 2,312 4,547 5,443 6,304 18,606
-------- -------- -------- ---------- ----------
Loss before income taxes................ (14,620) (40,481) (42,392) (585,256) (682,749)
Provision for income taxes.............. 50 50 50 350 500
-------- -------- -------- ---------- ----------
Loss from operations.................... (14,670) (40,531) (42,442) (585,606) (683,249)
Cumulative effect of change in
accounting for start-up costs......... (8,923) - - - (8,923)
-------- -------- -------- ---------- ----------
Net loss...................... (23,593) (40,531) (42,442) (585,606) (692,172)
Preferred stock dividend requirements... (261) (262) (261) (262) (1,046)
-------- -------- -------- ---------- ----------
Loss to common stockholders... $(23,854) $(40,793) $(42,703) $ (585,868) $ (693,218)
======== ======== ======== ========== ==========
Loss per common share:
Basic:
Loss from operations.............. $ (0.21) $ (0.58) $ (0.61) $ (8.32) $ (9.72)
Cumulative effect of change in
accounting for start-up costs... (0.13) - - - (0.13)
-------- -------- -------- ---------- ----------
Net loss...................... $ (0.34) $ (0.58) $ (0.61) $ (8.32) $ (9.85)
======== ======== ======== ========== ==========
Diluted:
Loss from operations.............. $ (0.21) $ (0.58) $ (0.61) $ (8.32) $ (9.72)
Cumulative effect of change in
accounting for start-up costs... (0.13) - - - (0.13)
-------- -------- -------- ---------- ----------
Net loss...................... $ (0.34) $ (0.58) $ (0.61) $ (8.32) $ (9.85)
======== ======== ======== ========== ==========
Shares used in computing loss
per common share:
Basic............................. 70,326 70,395 70,438 70,463 70,406
Diluted........................... 70,326 70,395 70,438 70,463 70,406
</TABLE>
38
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
OPERATING DATA
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
2000 QUARTERS
---------------------------------------
FIRST SECOND THIRD NINE MONTHS
---------- -------------- --------- ------------
<S> <C> <C> <C> <C>
Revenues:
Health services division:
Nursing centers............................................ $412,703 $413,159 $420,588 $1,246,450
Rehabilitation services.................................... 34,377 33,173 34,032 101,582
Other ancillary services................................... (5) (2) (1) (8)
Elimination................................................ (18,091) (18,509) (19,671) (56,271)
-------- -------- -------- ----------
428,984 427,821 434,948 1,291,753
Hospital division:
Hospitals.................................................. 253,591 250,027 244,391 748,009
Pharmacy................................................... 47,468 49,949 51,593 149,010
-------- -------- -------- ----------
301,059 299,976 295,984 897,019
-------- -------- -------- ----------
730,043 727,797 730,932 2,188,772
Elimination of pharmacy charges to Company nursing centers... (14,587) (14,373) (13,679) (42,639)
-------- -------- -------- ----------
$715,456 $713,424 $717,253 $2,146,133
======== ======== ======== ==========
Income (loss) from operations:
Operating income (loss):
Health services division:
Nursing centers......................................... $ 70,846 $ 77,482 $ 71,627 $ 219,955
Rehabilitation services................................. 490 (1,055) 2,841 2,276
Other ancillary services................................ 130 242 2,687 3,059
-------- -------- -------- ----------
71,466 76,669 77,155 225,290
Hospital division:
Hospitals............................................... 56,029 52,178 47,915 156,122
Pharmacy................................................ (1,181) 808 1,094 721
-------- -------- -------- ----------
54,848 52,986 49,009 156,843
Corporate overhead......................................... (29,365) (27,745) (29,988) (87,098)
Unusual transactions....................................... - 4,535 (9,236) (4,701)
Reorganization costs....................................... (3,065) (2,530) (4,745) (10,340)
-------- -------- -------- ----------
Operating income..................................... 93,884 103,915 82,195 279,994
Rent......................................................... (76,220) (76,788) (77,870) (230,878)
Depreciation and amortization................................ (17,902) (18,168) (17,464) (53,534)
Interest, net................................................ (15,033) (13,651) (12,925) (41,609)
-------- -------- -------- ----------
Loss before income taxes..................................... (15,271) (4,692) (26,064) (46,027)
Provision for income taxes................................... 500 500 500 1,500
-------- -------- -------- ----------
$(15,771) $ (5,192) $(26,564) $ (47,527)
======== ======== ======== ==========
</TABLE>
39
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
OPERATING DATA
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
1999 QUARTERS
-------------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Revenues:
Health services division:
Nursing centers................. $398,374 $397,930 $399,907 $ 398,033 $1,594,244
Rehabilitation services......... 54,365 50,234 46,088 45,044 195,731
Other ancillary services........ 16,263 12,855 10,477 3,932 43,527
Elimination..................... (34,205) (34,564) (31,770) (27,728) (128,267)
-------- -------- -------- --------- ----------
434,797 426,455 424,702 419,281 1,705,235
Hospital division:
Hospitals....................... 238,522 234,868 230,682 146,476 850,548
Pharmacy........................ 43,246 42,951 40,707 44,589 171,493
-------- -------- -------- --------- ----------
281,768 277,819 271,389 191,065 1,022,041
-------- -------- -------- --------- ----------
716,565 704,274 696,091 610,346 2,727,276
Elimination of pharmacy charges
to Company nursing centers...... (16,333) (15,382) (14,167) (15,753) (61,635)
-------- -------- -------- --------- ----------
$700,232 $688,892 $681,924 $ 594,593 $2,665,641
======== ======== ======== ========= ==========
Income (loss) from operations:
Operating income (loss):
Health services division:
Nursing centers.............. $ 59,122 $ 59,186 $ 55,881 $ 11,575 $ 185,764
Rehabilitation services...... 6,933 8,397 5,277 (17,374) 3,233
Other ancillary services..... 3,596 1,035 1,333 (1,798) 4,166
-------- -------- -------- --------- ----------
69,651 68,618 62,491 (7,597) 193,163
Hospital division:
Hospitals.................... 58,411 59,656 54,084 (35,248) 136,903
Pharmacy..................... 4,045 3,383 679 (7,388) 719
-------- -------- -------- --------- ----------
62,456 63,039 54,763 (42,636) 137,622
Corporate overhead.............. (27,773) (29,674) (27,297) (24,196) (108,940)
Unusual transactions............ - (20,827) - (391,591) (412,418)
Reorganization costs............ (2,312) (4,547) (5,443) (6,304) (18,606)
-------- -------- -------- --------- ----------
Operating income (loss)... 102,022 76,609 84,514 (472,324) (209,179)
Rent.............................. (75,452) (76,088) (77,423) (76,157) (305,120)
Depreciation and amortization..... (22,285) (21,612) (24,126) (25,173) (93,196)
Interest, net..................... (18,905) (19,390) (25,357) (11,602) (75,254)
-------- -------- -------- --------- ----------
Loss before income taxes.......... (14,620) (40,481) (42,392) (585,256) (682,749)
Provision for income taxes........ 50 50 50 350 500
-------- -------- -------- --------- ----------
$(14,670) $(40,531) $(42,442) $(585,606) $ (683,249)
======== ======== ======== ========= ==========
</TABLE>
40
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
OPERATING DATA (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
2000 QUARTERS
---------------------------------
FIRST SECOND THIRD NINE MONTHS
--------- --------- --------- -----------
<S> <C> <C> <C> <C>
Nursing center data:
End of period data:
Number of nursing centers:
Leased and owned........... 280 280 278
Managed.................... 40 41 39
--------- --------- ---------
320 321 317
========= ========= =========
Number of licensed beds:
Leased and owned........... 36,653 36,677 36,465
Managed.................... 4,262 4,436 4,070
--------- --------- ---------
40,915 41,113 40,535
========= ========= =========
Revenue mix %:
Medicare.................... 28 28 27 28
Medicaid.................... 48 48 50 49
Private and other........... 24 24 23 23
Patient days:
Medicare.................... 398,329 382,933 381,890 1,163,152
Medicaid.................... 1,918,732 1,917,429 1,960,359 5,796,520
Private and other........... 590,619 579,128 570,679 1,740,426
--------- --------- --------- ---------
2,907,680 2,879,490 2,912,928 8,700,098
========= ========= ========= =========
Hospital data:
End of period data:
Number of hospitals......... 56 56 56
Number of licensed beds..... 4,931 4,880 4,886
Revenue mix %:
Medicare.................... 58 53 56 56
Medicaid.................... 10 9 12 10
Private and other........... 32 38 32 34
Patient days:
Medicare.................... 188,063 177,083 167,946 533,092
Medicaid.................... 31,964 33,416 34,052 99,432
Private and other........... 51,747 51,743 50,567 154,057
--------- --------- --------- ---------
271,774 262,242 252,565 786,581
========= ========= ========= =========
</TABLE>
41
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
OPERATING DATA (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
1999 QUARTERS
---------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
--------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
Nursing center data:
End of period data:
Number of nursing centers:
Leased and owned........... 280 280 280 282
Managed.................... 13 13 13 13
--------- --------- --------- ---------
293 293 293 295
========= ========= ========= =========
Number of licensed beds:
Leased and owned........... 36,924 36,726 36,675 36,912
Managed.................... 1,661 1,661 1,661 1,661
--------- --------- --------- ---------
38,585 38,387 38,336 38,573
========= ========= ========= =========
Revenue mix %:
Medicare.................... 28 27 24 26 26
Medicaid.................... 47 48 51 50 49
Private and other........... 25 25 25 24 25
Patient days:
Medicare.................... 380,748 366,272 339,303 349,965 1,436,288
Medicaid.................... 1,867,554 1,911,111 1,967,721 1,972,577 7,718,963
Private and other........... 633,137 623,665 626,903 617,483 2,501,188
--------- --------- --------- --------- ----------
2,881,439 2,901,048 2,933,927 2,940,025 11,656,439
========= ========= ========= ========= ==========
Hospital data:
End of period data:
Number of hospitals......... 57 56 56 56
Number of licensed beds..... 4,937 4,935 4,907 4,931
Revenue mix %:
Medicare.................... 59 56 55 65 58
Medicaid.................... 10 10 11 11 11
Private and other........... 31 34 34 24 31
Patient days:
Medicare.................... 175,953 171,011 159,739 163,273 669,976
Medicaid.................... 29,939 29,675 30,674 29,561 119,849
Private and other........... 49,924 49,165 47,756 45,631 192,476
--------- --------- --------- --------- ----------
255,816 249,851 238,169 238,465 982,301
========= ========= ========= ========= ==========
</TABLE>
42
<PAGE>
ITEM 3. 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 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 maintains
a portion of its borrowings on a fixed rate, long-term basis. Prior to its
financial difficulties, the Company also entered into certain interest rate swap
transactions. The Company had no active interest rate swap agreements at
September 30, 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 declined significantly as a result of the Chapter
11 Cases, such amounts do not reflect any adjustments that might result from the
resolution 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.
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. For long-term debt, 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)
<TABLE>
<CAPTION>
EXPECTED MATURITIES FAIR
-------------------------------- VALUE
2000 2001 2002 2003 2004 THEREAFTER TOTAL 9/30/00
------- ------- -------- ------- -------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LIABILITIES:
Long-term debt, including
amounts due within one year:
Fixed rate..................... $ 3,174 $17,802 $ 19,453 $21,145 $ 7,574 $303,897 $373,045 $120,922
Average interest rate.......... 12.00% 12.00% 12.00% 12.00% 10.00% 10.00%
Variable rate.................. $22,503 $61,974 $128,640 $79,535 $177,344 $ 39,147 $509,143 $417,497
(a) Average interest rate
-------------
(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 the prime rate plus 2% to 3 1/2%.
</TABLE>
43
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. 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 September 29, 2000, the Company filed its
Proposed Plan with the Bankruptcy Court. See Note 3 of the Notes to Condensed
Consolidated Financial Statements for further discussion of the Chapter 11
Cases.
As previously reported, 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.
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.
44
<PAGE>
PART II. OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS:
10.1 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.
10.2 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.
10.3 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.
10.4 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.
10.5 Amendment to Commitment Letter dated August 31, 2000 by and among
Vencor, Inc. and the Borrowers under the Debtor-in-Possession Credit
Agreement, Ableco Finance LLC, Appaloosa Investment Limited
Partnership I, Franklin Mutual Advisers LLC, Van Kampen Prime Rate
Income Trust, Van Kampen Senior Floating Rate Fund, and Van Kampen
Senior Income Trust.
10.6 Second Amendment to Commitment Letter dated October 23, 2000 by and
among Vencor, Inc. and the Borrowers under the Debtor-in-Possession
Credit Agreement, Ableco Finance LLC, Appaloosa Investment Limited
Partnership I, Franklin Mutual Advisers LLC, Van Kampen Prime Rate
Income Trust, Van Kampen Senior Floating Rate Fund, and Van Kampen
Senior Income Trust.
10.7 Corporate Integrity Agreement between the Office of Inspector General
of the Department of Health and Human Services and Vencor, Inc.
10.8 Amendment No. 1 to the Vencor Retirement Savings Plan dated September
26, 2000.
10.9 Amendment No. 1 to the Retirement Savings Plan for Certain Employees
of Vencor and its Affiliates dated September 26, 2000.
27 Financial Data Schedule (included only in filings submitted under the
Electronic Data Gathering, Analysis, and Retrieval system).
45
<PAGE>
PART II. OTHER INFORMATION (CONTINUED)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED)
(B) REPORTS ON FORM 8-K:
The Company filed a Current Report on Form 8-K on August 9, 2000 announcing
that the Company had entered into the Corporate Integrity Agreement with the
OIG. The Company filed a Current Report on Form 8-K on September 9, 2000
announcing that the Bankruptcy Court approved the Company's motion to extend the
Company's exclusive right to file its plan of reorganization through September
29, 2000. The Company filed a Current Report on Form 8-K on September 25, 2000
announcing that the Company agreed with the DIP Lenders to extend the maturity
of the DIP Financing to October 31, 2000 and to amend certain other provisions
of the DIP Financing. This Form 8-K also announced the approval of an amendment
to the Commitment Letter to extend the date by which Bankruptcy Court approval
must be obtained for the Commitment Letter to be effective through October 31,
2000.
46
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VENCOR, INC.
Date: November 14, 2000 /s/ EDWARD L. KUNTZ
------------------------ --------------------
Edward L. Kuntz
Chairman of the Board, Chief
Executive Officer and President
Date: November 14, 2000 /s/ RICHARD A. SCHWEINHART
------------------------ ---------------------------
Richard A. Schweinhart
Senior Vice President and Chief
Financial Officer (Principal
Financial Officer)
47
