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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[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: 1-10989
Ventas, Inc.
(Exact name of registrant as specified in its charter)
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<S> <C>
Delaware 61-1055020
(State or other jurisdiction) (I.R.S. Employer Identification Number)
4360 Brownsboro Road, Suite 115 40207-1642
Louisville, Kentucky (Zip Code)
(Address of principal executive offices)
</TABLE>
(502) 357-9000
(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. [X] Yes [ ] 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, $.25 par value 68,418,096 Shares
1
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VENTAS, INC.
FORM 10-Q
INDEX
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Page
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PART I--FINANCIAL INFORMATION........................................................................... 3
Item 1. Financial Statements............................................................................ 3
Condensed Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999............ 3
Condensed Consolidated Statements of Income for the Three Months and Nine Months Ended
September 30, 2000 and September 30, 1999....................................................... 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2000 and September 30, 1999....................................................... 5
Notes To Condensed Consolidated Financial Statements............................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 32
PART II--OTHER INFORMATION.............................................................................. 33
Item 1. Legal Proceedings............................................................................... 33
Item 3. Defaults Upon Senior Securities................................................................. 33
Item 5. Other Information............................................................................... 33
Item 6. Exhibits and Reports on Form 8-K................................................................ 33
</TABLE>
2
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PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VENTAS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
(Unaudited) (Audited)
--------------- ----------------
<S> <C> <C>
Assets
Real estate investments:
Land............................................................ $ 120,891 $ 120,891
Building and improvements....................................... 1,061,656 1,061,656
--------------- ----------------
1,182,547 1,182,547
Accumulated depreciation........................................ (319,438) (287,756)
--------------- ----------------
Total real estate investments................................ 863,109 894,791
Cash and cash equivalents......................................... 96,138 139,594
Restricted cash--disputed federal, state and local tax refunds
and accumulated interest......................................... 28,223 -
Deferred financing costs, net..................................... 11,486 5,702
Notes receivable from employees................................... 3,386 3,611
Recoverable federal income taxes restricted in 2000............... 2,350 26,610
Other............................................................. 1,259 891
--------------- ----------------
Total assets................................................. $ 1,005,951 $ 1,071,199
=============== ================
Liabilities and stockholders' equity
Liabilities:
Notes payable and other debt.................................... $ 923,368 $ 974,247
Deferred gain on partial termination of interest rate swap
agreement...................................................... 21,605 21,605
Accounts payable and other accrued liabilities.................. 13,583 9,886
Other liabilities--disputed federal, state and local tax
refunds and accumulated interest............................... 30,573 26,610
Deferred income taxes........................................... 30,506 30,506
--------------- ----------------
Total liabilities............................................ 1,019,635 1,062,854
--------------- ----------------
Commitments and contingencies
Stockholders' equity:
Preferred stock, unissued....................................... - -
Common stock.................................................... 18,402 18,402
Capital in excess of par value.................................. 132,226 139,723
Unearned compensation on restricted stock....................... (1,680) (2,080)
Retained earnings (deficit)..................................... (17,199) 6,409
--------------- ----------------
131,749 162,454
Treasury stock.................................................. (145,433) (154,109)
--------------- ----------------
Total stockholders' equity (deficit)......................... (13,684) 8,345
--------------- ----------------
Total liabilities and stockholders' equity................... $ 1,005,951 $ 1,071,199
=============== ================
</TABLE>
See notes to condensed consolidated financial statements.
3
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VENTAS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share amounts)
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<CAPTION>
Three Months Ended Nine Months Ended
----------------------------------- --------------------------------
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues:
Rental income...................................... $58,567 $57,544 $174,288 $171,155
Interest and other income.......................... 2,312 1,767 5,665 2,698
--------- ---------- ---------- ----------
60,879 59,311 179,953 173,853
Expenses:
General and administrative......................... 2,602 1,416 7,387 4,783
Professional fees.................................. 2,735 3,810 9,328 7,556
Non-recurring employee severance costs............. - - 355 1,272
Loss on uncollectible amounts due from tenant...... 12,469 7,500 35,837 7,500
Amortization of restricted stock grants............ 309 216 1,044 1,083
Depreciation on real estate investments............ 10,522 10,944 31,682 32,832
Interest........................................... 23,661 22,398 71,287 65,296
--------- ---------- ---------- ----------
52,298 46,284 156,920 120,322
--------- ---------- ---------- ----------
Income before extraordinary loss........................ 8,581 13,027 23,033 53,531
Extraordinary loss on extinguishment of debt............ - - (4,207) -
--------- ---------- ---------- ----------
Net income.............................................. $ 8,581 $13,027 $ 18,826 53,531
========= ========== ========== ==========
Earnings per common share:
Basic:
Income before extraordinary loss.............. $ 0.13 $ 0.19 $ 0.34 0.79
Extraordinary loss on extinguishment of debt.. - - (0.06) -
--------- ---------- ---------- ----------
Net income.................................... $ 0.13 $ 0.19 $ 0.28 0.79
========= ========== ========== ==========
Diluted:
Income before extraordinary loss.............. $ 0.13 $ 0.19 $ 0.34 0.79
Extraordinary loss on extinguishment of debt.. - - (0.06) -
--------- ---------- ---------- ----------
Net income.................................... $ 0.13 $ 0.19 $ 0.28 0.79
========= ========== ========== ==========
Shares used in computing earnings per common share:
Basic.............................................. 68,038 67,773 67,986 67,743
Diluted............................................ 68,224 68,002 68,077 68,053
Dividends declared and paid per common share............ $ 0.62 $ - $ 0.62 0.39
========= ========== ========== =========
</TABLE>
See notes to condensed consolidated financial statements
4
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VENTAS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
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<CAPTION>
Nine Months Ended Nine Months Ended
September 30, September 30,
2000 1999
--------------------- --------------------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................................... $ 18,826 $ 53,531
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation............................................................ 31,739 32,835
Amortization of deferred financing costs................................ 2,625 3,652
Amortization of restricted stock grants................................. 1,044 1,083
Normalized rents........................................................ (113) -
Realized gain on sale of real estate properties......................... - (254)
Extraordinary loss on extinguishment of debt............................ 4,207 -
Provision for reserve on amount due from Vencor, Inc.................... - 7,500
Changes in operating assets and liabilities:
Increase in amount due from Vencor, Inc................................. - (15,667)
Increase in restricted cash............................................. (28,223) -
Decrease (increase) in accounts receivable and other assets............. 23,957 (1,093)
Increase (decrease) in accounts payable and accrued and other
liabilities........................................................... 8,173 (1,444)
--------------------- --------------------
Net cash provided by operating activities............................ 62,235 80,143
Cash flows from investing activities:
Purchase of furniture and equipment........................................ - (299)
Sale of real estate properties............................................. - 254
Repayments of notes receivable from employee........................ 225 295
--------------------- --------------------
Net cash provided by investing activities............................ 225 250
Cash flows from financing activities:
Net change in borrowings under revolving line of credit.................... - 173,143
Repayment of long-term debt................................................ (50,879) (129,142)
Proceeds from partial termination of interest rate swap agreement.......... - 21,605
Payment of deferred financing costs........................................ (12,616) -
Issuance of restricted stock............................................... 14 4
Cash distribution to stockholders.......................................... (42,435) (26,489)
--------------------- --------------------
Net cash (used in) provided by financing activities.................. (105,916) 39,121
--------------------- --------------------
(Decrease) increase in cash and cash equivalents............................. (43,456) 119,514
Cash and cash equivalents--beginning of period............................... 139,594 338
--------------------- --------------------
Cash and cash equivalents--end of period..................................... $ 96,138 $ 119,852
===================== ====================
</TABLE>
See notes to condensed consolidated financial statements
5
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VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--REPORTING ENTITY
Ventas, Inc. ("Ventas" or the "Company") is a Delaware corporation that
qualified as a real estate investment trust ("REIT") under the Internal Revenue
Code of 1986, as amended, beginning with the tax year ending December 31, 1999.
Although the Company intends to continue to qualify as a REIT for the tax year
ending December 31, 2000 and subsequent tax years, it is possible that economic,
market, legal, tax or other considerations may cause the Company to fail or
elect not to continue to qualify as a REIT in any such tax year. The Company
owns or leases 45 hospitals (comprised of two acute care hospitals and 43 long-
term acute care hospitals), 218 nursing facilities and eight personal care
facilities in 36 states, as of September 30, 2000. The Company conducts
substantially all of its business through a wholly owned operating partnership,
Ventas Realty, Limited Partnership ("Ventas Realty"). The Company operates in
one segment which consists of owning and leasing health care facilities and
leasing or subleasing such facilities to third parties.
NOTE 2--BASIS OF PRESENTATION
The accompanying unaudited Condensed Consolidated Financial Statements have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
for a fair presentation have been included. Operating results for the nine-month
period ended September 30, 2000 are not necessarily an indication of the results
that may be expected for the year ending December 31, 2000. The Condensed
Consolidated Balance Sheet as of December 31, 1999 has been derived from the
Company's audited consolidated financial statements for the year ended December
31, 1999. These financial statements and related notes should be read in
conjunction with the financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1999.
In June 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities," which amends
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
SFAS 133 was previously amended by SFAS No. 137 "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133," which deferred the effective date of SFAS No. 133 to fiscal
years beginning after June 15, 2000. The Company expects to adopt SFAS 133 and
SFAS 138 effective January 1, 2001. SFAS 133 and SFAS 138 will require the
Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
recognized immediately in earnings. Based on the Company's derivative positions
and their related fair values of approximately $12.0 million at September 30,
2000, as well as the $21.6 million gain incurred but not yet reflected in net
income on the terminated derivative position (see "Note 4--Bank Credit
Facility"), the Company estimates that upon adoption of SFAS 133 and SFAS 138 it
would report a positive adjustment of $33.6 million in other comprehensive
income. The Company was not required to report the $12.0 million unrealized gain
for the nine month period ended September 30, 2000.
In December 1999, the Securities and Exchange Commission (the "Commission")
issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements." SAB 101 summarizes certain of the Commission's views in
applying accounting principles generally accepted in the United States to
revenue recognition in financial statements. In June 2000, the Commission issued
SAB 101B to defer the effective date of implementation of SAB 101 to the fourth
quarter 2000. The Company does not expect the adoption of SAB 101 to have a
material effect on its financial position or results of operations.
6
<PAGE>
VENTAS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 3--CONCENTRATION OF CREDIT RISK AND RECENT DEVELOPMENTS
Concentration of Credit Risk
As of September 30, 2000, approximately 70.2% of the Company's real estate
investments (based on cost) related to skilled nursing facilities. The remaining
real estate investments consist of hospitals and personal care facilities. The
Company's facilities are located in 36 states, and lease revenues from
operations in any one state do not account for more than ten percent (10%) of
revenues. The Company leases all of its hospitals and 210 of its nursing
facilities to Vencor, Inc. ("Vencor") and certain of its subsidiaries under four
master lease agreements relating to 254 facilities and a single nursing facility
lease (individually a "Master Lease" and collectively the "Master Leases").
Because the Company leases substantially all of its properties to Vencor and
Vencor is the primary source of the Company's revenues, Vencor's financial
condition and ability to satisfy its rent obligations under the Master Leases
and certain other agreements will significantly impact the Company's revenues
and its ability to service its indebtedness and to make distributions to its
stockholders. The operations of Vencor have been negatively impacted by changes
in governmental reimbursement rates, by its current level of indebtedness and by
certain other factors. The Company, Vencor and Vencor's major creditors have
been engaged in negotiations to restructure Vencor's debt and lease obligations
since the second quarter of 1999. On September 13, 1999, Vencor filed for
protection under chapter 11 of Title 11 of the United States Code (the
"Bankruptcy Code") in Wilmington, Delaware. On September 29, 2000 Vencor filed a
preliminary plan of reorganization with the Bankruptcy Court (the "Preliminary
Plan of Reorganization"). The Preliminary Plan of Reorganization contains
certain, but not all, of the material terms for the restructuring of Vencor's
debt and lease obligations. The Company does not support the terms contained in
the Preliminary Plan of Reorganization and has continued to engage in
discussions with Vencor and Vencor's major creditors on the terms of a
restructuring of Vencor's debt and lease obligations. Vencor has advised the
Company that Vencor's major creditors support the material economic terms
contained in the Preliminary Plan of Reorganization. Vencor must submit its
final plan of reorganization to the Company and various classes of Vencor
creditors for approval. There can be no assurance that a plan of reorganization
will not be confirmed over the objection of the Company or any creditor. The
Company will not vote to approve any plan of reorganization that is not
acceptable to the Company taking into consideration all facts and circumstances
at the time. There can be no assurance (i) that Vencor will be successful in
obtaining the approval of its creditors or the Company for a restructuring plan
on the terms contained in the Preliminary Plan of Reorganization or on other
terms, (ii) that the final terms of any such plan will be acceptable to the
Company, Vencor and/or its creditors, or (iii) that the final restructuring plan
will not have a material adverse effect on the business, financial condition,
results of operation and liquidity of the Company, on the Company's ability to
service its indebtedness and on the Company's ability to make distributions to
its stockholders as required to continue to qualify as a REIT (a "Material
Adverse Effect"). See "--Recent Developments Regarding Vencor."
Recent Developments Regarding Vencor
On September 13, 1999, Vencor filed for protection under chapter 11 of the
Bankruptcy Code. Under the automatic stay provisions of the Bankruptcy Code, the
Company is currently prevented from exercising certain rights and remedies under
the various agreements that the Company and Vencor entered into at the time the
Company spun off its health care operations to Vencor (the "1998 Spin Off"),
including the Master Leases (the "Spin Agreements"), and from taking certain
enforcement actions against Vencor.
The Company, Vencor and Vencor's major creditors have engaged in negotiations
both prior and subsequent to Vencor's bankruptcy filing to restructure Vencor's
debt and lease obligations. At the time of Vencor's filing for protection under
the Bankruptcy Code, Vencor's major creditors, Vencor and Ventas agreed upon the
terms of a preliminary, non-binding agreement regarding Vencor's plan of
reorganization (the "September 1999 Agreement in Principle"). After the filing
of Vencor's bankruptcy petition, Vencor and certain of its major creditors
asserted that events arising after the filing of Vencor's bankruptcy petition
have required adjustments in the Vencor financial projections utilized as a
basis for the structure of the September 1999 Agreement in Principle. Vencor
and these major creditors advised the Company of their unwillingness to proceed
under the terms of the September 1999 Agreement in Principle.
7
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In the first quarter of 2000, the Company, Vencor and Vencor's major creditors
entered into discussions regarding proposed changes to the terms contained in
the September 1999 Agreement in Principle as well as other matters relating to
Vencor's plan of reorganization. Although the parties did not reach agreement
on the terms of an alternative restructuring of Vencor's debt and lease
obligations, Vencor, with the apparent support of its major creditors, filed its
Preliminary Plan of Reorganization on September 29, 2000. The Preliminary Plan
of Reorganization contains certain, but not all, of the material terms for a
restructuring of Vencor's debt and lease obligations. The Company does not
support the Preliminary Plan of Reorganization. The Company has continued to
engage in discussions with Vencor and Vencor's major creditors in an effort to
reach an agreement for the restructuring of Vencor's debt and lease obligations
that all parties can support. The Company will not vote to approve any plan of
reorganization that is not acceptable to the Company, taking into consideration
all facts and circumstances at the time. The Company does not intend to update
the foregoing information until the Company, Vencor and Vencor's major creditors
agree upon the terms of Vencor's plan of reorganization. There can be no
assurance that Vencor will be successful in obtaining the approval of its
creditors or the Company for a plan of reorganization, that any such plan will
not be confirmed over the objection of the Company or any creditor, that any
such plan will be on terms acceptable to the Company, Vencor and its creditors,
or that any plan of reorganization will not have a Material Adverse Effect on
the Company.
Under the terms of the Preliminary Plan of Reorganization, the Company would
receive annual rent of $180.7 million ($15.05 million per month) beginning May
1, 2001 through April 30, 2002, of which $2.6 million would be non-cash accrued
rent. The Company would retain all rent received through the effective date of
the Preliminary Plan of Reorganization. For the interim period, if any, between
the effective date of the Preliminary Plan of Reorganization and May 1, 2001,
the Company would receive monthly rent of $14.55 million. The Company would
also receive (a) in addition to the current 2% annual cash escalator contained
in the Master Leases, a 1-1/2% annual non-cash rent escalator that would accrue
at 6% per annum until the occurrence of certain specified events, at which time
the accrual with interest shall be due and payable and thereafter the 1-1/2%
rent escalator would convert to a cash escalator totaling 3-1/2% per year; (b) a
one time right to reset the rents for the facilities, exercisable 5 1/2 years
after the effective date of the Preliminary Plan of Reorganization on a Master
Lease by Master Lease basis, to a then fair market rental rate, for a total fee
of $5 million payable on a pro-rata basis at the time of exercise under any
Master Lease; (c) 10% of the common stock in reorganized Vencor (the Company, in
order to qualify as a REIT, may not hold more than 10% of the total combined
voting power, the total value of all securities or the total number of shares in
Vencor. Management of the Company is evaluating alternatives for dealing with
any Vencor equity ultimately received so as to comply with the 10% limitation);
and (d) a reaffirmation and continuation of Vencor's indemnity obligations under
the Spin Agreements.
Other terms of the Preliminary Plan of Reorganization include: (a) the Vencor
Senior Bank Debt would be restructured as follows (i) the principal and accrued
interest amount would be reduced from approximately $570 million to
approximately $300 million, (ii) the restructured debt would have a term of
seven years and bear interest at LIBOR plus 450 basis points, with no required
amortization, (iii) no interest would accrue on the restructured debt for the
two quarters following the effective date of the Preliminary Plan of
Reorganization, and (iv) the holders of the Vencor Senior Bank Debt would
receive 65.5% of the common stock of restructured Vencor; (b) the holders of the
Vencor Senior Subordinated Notes would convert their claims into approximately
24.5% of the common stock in restructured Vencor and would receive warrants in
the restructured Vencor which would be divided into two tranches and would be
exercisable at equity valuations of $450 million and $500 million; and (c)
Vencor would receive a revolving credit facility for its working capital needs
upon emergence from bankruptcy.
The Preliminary Plan of Reorganization contemplates a comprehensive settlement
of all civil and administrative claims against the Company and Vencor arising
from the participation of Vencor facilities in various federal health benefit
programs. The majority of these claims arise from lawsuits filed under the qui
tam, or whistleblower, provision of the Federal Civil False Claims Act, which
allows private citizens to bring suit in the name of the United States. See
"Note 5--Litigation." The United States Department of Justice, Civil Division,
filed two proofs of claim in the chapter 11 bankruptcy proceedings of Vencor and
certain affiliated debtors covering these claims and the qui tam suits. The
claims aggregate approximately $1.3 billion, including treble damages. The
Department of Justice has informed the Company that it is the Department of
Justice's position that, if liability exists, the Company and Vencor will be
jointly and severally liable for the portion of such claims related to the
period prior to the date of the 1998 Spin Off. Under the comprehensive
settlement of these claims as contemplated in the Preliminary Plan of
Reorganization, the Company would pay $103.6 million to the federal government,
of which $34 million would be paid at the effective date of the Preliminary Plan
of Reorganization. The balance of
8
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$69.6 million would bear interest at 6% per annum and be payable in equal
quarterly installments over a five year term commencing on the last day of the
first full quarter following the quarter in which the Preliminary Plan of
Reorganization becomes effective. Vencor would pay the federal government a
total of $25.9 million as follows: $10 million on the effective date of the
Preliminary Plan of Reorganization and the balance (with interest at 6% per
annum) during the first two quarters following the effective date of the
Preliminary Plan of Reorganization. The Company and Vencor continue to be
engaged in advanced settlement discussions with the federal government to
finalize the precise terms of the comprehensive settlement contemplated under
the Preliminary Plan of Reorganization. Any settlement of these claims and suits
among the Company, Vencor and the federal government will not become effective
unless and until a plan of reorganization for Vencor which is acceptable to the
Company is approved and confirmed. There can be no assurance that a settlement
will be reached regarding these claims and suits, or, if reached, that the
settlement will be on terms acceptable to the Company.
Vencor has stated that it intends to set December 6, 2000 as the disclosure
statement hearing date for a Vencor plan of reorganization. If the Delaware
bankruptcy court approves the disclosure statement at that time, it could be
mailed to creditors in December, 2000 and they could vote on the plan of
reorganization in January, 2001. There can be no assurance that these dates will
not change.
Subject to any defenses available to the Company, it is an event of default
under the Amended and Restated Credit, Security, Guaranty and Pledge Agreement
(the "Amended Credit Agreement") that the Company and all of the lenders under
its prior credit agreement entered into on January 31, 2000, if Vencor's plan of
reorganization is not effective on or before December 31, 2000. The Company has
initiated discussions with the administrative agent for its lenders under the
Amended Credit Agreement to obtain a waiver or amendment of this covenant. Under
the Amended Credit Agreement, a waiver or amendment of this covenant must be
approved by lenders holding (in the aggregate) greater than 50% of the total
credit exposure under the Amended Credit Agreement. The Company believes that
the holders of a majority of the Vencor bank indebtedness also hold a
substantial portion of the total credit exposure under the Amended Credit
Agreement. There can be no assurance (i) that a plan of reorganization for
Vencor will become effective on or before December 31, 2000, (ii) that the
Company will obtain a waiver or amendment of the covenant if a plan of
reorganization for Vencor is not effective on or before December 31, 2000, (iii)
that the terms of such a waiver or amendment would not have a Material Adverse
Effect on the Company, or (iv) that the failure to obtain such a waiver or
amendment would not have a Material Adverse Effect on the Company. See "Note
4 -- Bank Credit Facility."
On or about June 14, 2000, Vencor filed a motion with the Delaware bankruptcy
court seeking approval of a ninth amendment (the "Ninth DIP Amendment") to
Vencor's debtor in possession financing agreement (the "DIP facility"). The
proposed Ninth DIP Amendment would become effective if litigation is commenced
between Vencor and the Company relating to the Master Leases and/or the 1998
Spin Off (a "Litigation Event" as defined in the Ninth DIP Amendment). The
Ninth DIP Amendment provides, among other things, that (a) the proceeds of the
DIP facility would be available to fund, among other things, litigation expenses
and (b) the events of default under the DIP facility would be revised to delete
certain events relating to the Company and to permit a Litigation Event. The
Company objected to the relief requested by Vencor. In connection with the
ongoing discussions among Vencor, its creditors and the Company, Vencor and the
Company agreed to adjournments of the hearing on the motion, and each party has
agreed that until November 9, 2000 (the adjourned hearing date) it would (i)
continue to perform under the Rent Stipulation (as defined below), (ii) not
terminate the Rent Stipulation and (iii) not commence litigation against the
other party. The Ninth DIP Amendment would have been effective if, prior to
September 30, 2000, Vencor obtained the Delaware bankruptcy court's approval of
the Ninth DIP Amendment and litigation with the Company was commenced. On
September 20, 2000 the Delaware bankruptcy court granted Vencor's motion to
extend the deadline for the receipt of court approval of the Ninth DIP Amendment
and the commencement of litigation with the Company to October 31, 2000. On
October 25, 2000, the court granted an additional extension of this deadline to
January 31, 2001.
On October 25, 2000 the Delaware bankruptcy court granted Vencor's motion to
extend the expiration date of Vencor's DIP facility (unamended by the Ninth DIP
Amendment) from October 31, 2000 to January 31, 2001.
The Company filed its proofs of claim in the chapter 11 bankruptcy proceedings
of Vencor and certain affiliated debtors on May 17, 2000. The Company asserted
approximately $4.3 billion in the proofs of claim. The proofs of claim include
rent due at the contract rental rates set forth in the Master Leases through the
initial term of the Master Leases as well as other liquidated and unliquidated
amounts owed to the Company under the Master Leases and certain other agreements
between the Company and Vencor and/or certain of the other affiliated debtors.
During the Company's discussions with Vencor, Vencor asserted various
potential claims against the Company arising out of the 1998 Spin Off. See "Note
5--Litigation." The Company intends to defend these claims vigorously if they
are asserted in a court, arbitration or mediation proceeding. If these claims
were to prevail, they could have a Material Adverse Effect on the Company.
9
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On October 2, 2000, the Florida Agency for Health Care Administration ("ACHA")
notified Vencor that effective November 1, 2000, ACHA was canceling the Medicaid
contracts with Vencor for three Florida nursing facilities owned by the Company
and operated by Vencor. On October 10, 2000, the United States District Court in
Tampa, Florida granted Vencor's request for a temporary restraining order
staying ACHA's cancellation of the Medicaid contracts with Vencor and the
relocation of the Medicaid patients at these facilities. On October 19, 2000,
Vencor and ACHA agreed to a settlement resolving this matter. Under the
settlement ACHA agreed to rescind the notices of cancellation of the Medicaid
contracts at these facilities. Vencor agreed to immediately implement a program
to improve the quality of care at the three facilities. Vencor also agreed to
implement the improved quality of care plan at its other Florida nursing
facilities over the next six months.
On November 6, 2000, Vencor filed a first amended plan of reorganization (the
"First Amended Plan") with the Bankruptcy Court incorporating into the
Preliminary Plan of Reorganization the terms relating to the proposed
comprehensive settlement of the claims by the United States against the Company
and Vencor. The First Amended Plan does not make any other changes to the terms
of the Preliminary Plan of Reorganization, which remains subject to further
amendments and supplements.
The Rent Stipulation
In connection with the bankruptcy filing by Vencor, the Company and Vencor
entered into a stipulation (the "Rent Stipulation") for the payment by Vencor to
the Company of approximately $15.1 million per month starting in September 1999,
to be applied against the total amount of minimum monthly base rent that is due
and payable under the Master Leases. The bankruptcy court approved the Rent
Stipulation on September 13, 1999. During the period in which the Rent
Stipulation is in effect, Vencor has agreed to fulfill all of its obligations
under the Spin Agreements as such obligations become due, including its
obligation to indemnify and defend Ventas from and against all claims arising
out of the Company's former health care operations or assets or liabilities
transferred to Vencor in the 1998 Spin Off. Vencor has not, however, agreed to
assume the Spin Agreements and has reserved its right to seek to reject such
agreements pursuant and subject to the applicable provisions of the Bankruptcy
Code. A termination of the Rent Stipulation and/or rejection by Vencor of the
Spin Agreements could have a Material Adverse Effect on the Company.
The payments under the Rent Stipulation are required to be made by the fifth
day of each month, or on the first business day thereafter. Starting in
September, 1999, the difference between the amount of minimum monthly base rent
due under the Company's Master Leases with Vencor, and the monthly payment of
approximately $15.1 million accrues as a superpriority administrative expense in
Vencor's bankruptcy proceeding, junior in right only to the following: (i) any
liens or superpriority claims provided to lenders under the DIP facility; (ii)
any fees due to the Office of the United States Trustee; (iii) certain fees of
Vencor's professionals; (iv) any liens or superpriority claims granted to pre-
petition secured creditors as adequate protection for their claims under the
interim DIP facility order issued by the bankruptcy court and the final DIP
facility order; and (v) pre-petition liens granted to the lenders under Vencor's
credit agreement, as amended, and related agreements, to the extent such pre-
petition claims are allowed as secured, subject to challenge in the Vencor
bankruptcy proceeding. The monthly payment of approximately $15.1 million under
the Rent Stipulation is not subject to offset, recoupment or challenge. The
Company has written off the difference between the monthly base rent payable
pursuant to the Master Leases and the Rent Stipulation for the nine month period
ended September 30, 2000 as a loss on uncollectible amounts due from tenant.
The Rent Stipulation by its terms initially would have expired on October 31,
1999, but automatically renews for one-month periods unless either party
provides a fourteen-day notice of its election to terminate the Rent
Stipulation. To date, no such notice of termination has been given. The Rent
Stipulation may also be terminated prior to its expiration upon a payment
default by Vencor, the consummation of a plan of reorganization for Vencor, or
the occurrence of certain events under the DIP facility. There can be no
assurance as to how long the Rent Stipulation will remain in effect or that
Vencor will continue to perform under the terms of the Rent Stipulation.
The Rent Stipulation also addresses an agreement by Ventas and Vencor
concerning any statutes of limitations and other time constraints. See "--The
Tolling Agreement" below.
The Tolling Agreement
The Company and Vencor have also entered into an agreement (the "Tolling
Agreement") pursuant to which they have agreed that any statutes of limitations
or other time constraints in a bankruptcy proceeding, including the
10
<PAGE>
assertion of certain "bankruptcy avoidance provisions" that might be asserted by
one party against the other, are extended or tolled for a specified period. That
period currently expires on the fifth business day following the termination
date of the Rent Stipulation. Pursuant to the Rent Stipulation, the Tolling
Agreement does not shorten any time period otherwise provided under the
Bankruptcy Code.
Recent Developments Regarding Income Taxes
On February 3, 2000 the Company received a refund (the "Refund") of
approximately $26.6 million from the Internal Revenue Service representing the
refund of income taxes paid by it from 1996 and 1997 and accrued interest
thereon as a result of a carryback of losses reported in the Company's 1998
federal income tax return. Although the Company believes that it is entitled to
the Refund pursuant to the terms of a tax allocation agreement (the "Tax
Allocation Agreement") the Company entered into with Vencor in connection with
the 1998 Spin Off and on other legal grounds, the Internal Revenue Service may
assert a right to all or some portion of the Refund based upon the review of the
federal income tax returns of the Company (which prior to May 1, 1998 operated
under the name Vencor). Consistent with prior periods, the Internal Revenue
Service has recently advised the Company that the Internal Revenue Service will
review the Company's 1997 and 1998 federal income tax returns. In addition, the
federal income tax returns of the Company for subsequent tax years are also
subject to review by the Internal Revenue Service. The ultimate outcome of
these matters and the resulting effects on related operating loss carryforwards
has not been determined and, accordingly, no additional provisions for resulting
tax liabilities, if any, have been made in the Condensed Consolidated Financial
Statements of the Company at September 30, 2000. Under the Tax Allocation
Agreement, Vencor has indemnified the Company for certain of these tax
liabilities, should they exist. There can be no assurance that Vencor will have
sufficient assets, income and access to financing to enable it to satisfy its
indemnity obligations under the Tax Allocation Agreement or that Vencor will
continue to honor such indemnification obligations.
The Internal Revenue Service recently completed its review of the Company's
federal income tax returns for the tax years ending December 31, 1995 and
December 31, 1996. The Company will likely receive a refund of approximately
$2.4 million (the "Audit Refund") as a result of the audit adjustments to the
Company's 1995 and 1996 federal income tax returns. The Company expects that the
Audit Refund will be deposited into the segregated accounts maintained under the
"Tax Stipulation," as defined below, provided that the Tax Stipulation is in
effect at the time the Audit Refund is received.
The United States Department of the Treasury--Internal Revenue Service has
filed a proof of claim in the Vencor bankruptcy proceeding asserting a claim
against Vencor to the Refund. Vencor, in turn, has asserted that it is entitled
to the Refund pursuant to the terms of the Tax Allocation Agreement and on other
legal grounds. Vencor and the Company are also engaged in a dispute relating to
the entitlement to certain other federal, state and local tax refunds, in
addition to the Refund.
The Company, Ventas Realty, and Vencor entered into a stipulation relating to
certain of these federal, state and local tax refunds (including the Refund) on
or about May 23, 2000 (the "Tax Stipulation"). Under the terms of the Tax
Stipulation, which was approved by the Vencor bankruptcy court on May 31, 2000,
proceeds of certain federal, state and local tax refunds for tax years ending
prior to or including April 30, 1998, received by either company on or after
September 13, 1999, with interest thereon from the date of deposit at the lesser
of the actual interest earned and 3% per annum, are to be held by the recipient
of such refunds in segregated interest bearing accounts. The Tax Stipulation
contains notice provisions relating to the withdrawal of funds by either company
from the segregated accounts. The Tax Stipulation terminates automatically on
the earlier of (a) the date of termination of the Rent Stipulation, and (b) the
date Vencor provides notice of its intent to terminate the Rent Stipulation.
Both companies reserve all rights and claims regarding the refund proceeds under
the Tax Stipulation.
There can be no assurance as to how matters related to the tax refunds or any
tax assessed for these years or other years of the Company will be resolved or
as to whether the Company will ultimately retain all or a portion of any of the
refund proceeds, including the Refund and the Audit Refund. Accordingly, the
refund proceeds (including the Refund) and interest earned thereon, have been
classified with the other liabilities of the Company at September 30, 2000 in
the Condensed Consolidated Financial Statements.
Under the terms of the Preliminary Plan of Reorganization, Vencor has proposed
that the Company and Vencor enter into a tax escrow agreement that provides for
the escrow of certain federal, state and local tax refunds, including the
Refund, effective upon confirmation of the Preliminary Plan of Reorganization.
The Company has not agreed to enter into such tax escrow agreement.
11
<PAGE>
No adjustments have been recorded to the Company's deferred income tax
liability. As a former C corporation for federal income tax purposes, the
Company potentially remains subject to corporate level taxes for any asset
dispositions between January 1, 1999 to December 31, 2008 ("built-in gains
tax"). The amount of income potentially subject to corporate level tax is
generally equal to the excess of the fair value of the asset over its adjusted
tax basis as of December 31, 1998, or the actual amount of taxable gain,
whichever is greater. Any gain recognized during this period of time could be
offset by available net operating losses and capital loss carryforwards. The
remaining deferred income tax liability at September 30, 2000 reflects a
previously established liability to be utilized for any built-in gain tax
incurred on assets that are disposed of within the subsequent 10-year period.
No net provision for income taxes has been recorded in the Condensed
Consolidated Financial Statements for the nine months ended September 30, 2000
due to the Company's current intention to continue to qualify as a REIT,
distribute 95% of its 2000 taxable income as a dividend and the existence of net
operating losses that offset the remaining liability for federal corporate
income taxes for the 2000 tax year. Although the Company intends to continue to
qualify as a REIT for the 2000 tax year and to distribute 95% of its 2000
taxable income, it is possible that economic, market, legal, tax or other
considerations may cause the Company to fail or elect not to continue to qualify
as a REIT for the 2000 tax year and distribute 95% of its 2000 taxable income.
The Company's failure to continue to qualify as a REIT could have a Material
Adverse Effect on the Company.
Recent Developments Regarding Dividends
The Company filed its federal income tax return for the tax year ending
December 31, 1999 (the "1999 Tax Year") on September 14, 2000 electing to
qualify as a REIT for the 1999 Tax Year. On September 8, 2000, the Company
declared a cash dividend on its common stock of $42.4 million, or $0.62 per
common share. The Company paid the dividend on September 28, 2000 to
stockholders of record on September 18, 2000. This dividend, when combined with
the cash dividend of $26.5 million, or $0.39 per common share, paid by the
Company on February 17, 1999 to stockholders of record on January 29, 1999,
represents at least 95% of the Company's reported taxable income for the 1999
Tax Year. This combined dividend, together with the satisfaction of certain
other criteria, enabled the Company to elect REIT status for the 1999 Tax Year.
The Company intends to continue to qualify as a REIT for the tax year ending
December 31, 2000 (the "2000 Tax Year") and subsequent tax years. Such
qualification requires the Company to declare a distribution of 95% of its
taxable income for any given tax year not later than September 15 of the year
following the end of the tax year in respect of which the dividend is to be paid
(i.e. September 15, 2001 for the 2000 Tax Year) and pay such dividend not later
than December 31 of that same year (i.e. December 31, 2001 for the 2000 Tax
Year), or, if earlier, prior to the payment of the first regular dividend for
the then current year. While such distributions are not required to be made
quarterly, if they are not made by January 31 of the year following the end of
the tax year in respect of which the dividend is to be paid (i.e. January 31,
2001 for the 2000 Tax Year), the Company is required to pay a 4% non-deductible
excise tax on the difference between 85% of its taxable net income for the year
in respect of which the dividend is to be paid and the aggregate amount of
dividends paid for that tax year on or prior to January 31 of the year following
the year in respect of which the dividend is to be paid. The Company did not
declare or pay a dividend in the first, second or third quarters of the 2000 Tax
Year. The Company currently intends to distribute 95% of its taxable income for
the 2000 Tax Year, but there can be no assurance that it will do so or when such
distribution will be made. The Company's dividend for the 2000 Tax Year may be
satisfied by a distribution of a combination of cash and other property or
securities.
The amount of the total dividend declared and paid by the Company for the 1999
Tax Year should not be viewed as an indication of future dividend levels, which
are likely to be lower. The Company is unable to predict the amount or timing
of future dividends due to the uncertainty over the restructuring of Vencor.
It is important to note for purposes of the required REIT distributions that
the Company's taxable income may vary significantly from historical results and
from current income determined in accordance with accounting principles
generally accepted in the United States depending on the resolution of a variety
of factors. Under certain circumstances, the Company may be required to make
distributions in excess of FFO (as defined by the National Association of Real
Estate Investment Trusts) in order to meet such distribution requirements. In
the event that timing differences or cash needs occur, the Company may find it
necessary to borrow funds or to issue equity securities (there being no
assurance that it will be able to do so) or, if possible, to pay taxable stock
dividends, distribute other property or securities or engage in a transaction
intended to enable it to meet the REIT distribution requirements. The Company's
ability to engage in certain of these transactions is restricted by the terms of
the Amended Credit Agreement. Any such transaction would likely require the
consent of the "Required Lenders"
12
<PAGE>
under the Amended Credit Agreement, and there can be no assurance that such
consent would be obtained. In addition, the failure of Vencor to make rental
payments under the Master Leases would impair materially the ability of the
Company to make distributions. Consequently, there can be no assurance that the
Company will be able to make distributions at the required distribution rate or
any other rate.
Although the Company intends to continue to qualify as a REIT for the 2000 Tax
Years and subsequent tax years, it is possible that economic, market, legal, tax
or other considerations may cause the Company to fail or elect not to continue
to qualify as a REIT in any such tax year. If the Company were to fail or elect
not to continue to qualify as a REIT in any such tax year, the Company would be
subject to 35% federal income tax and to the applicable state and local income
taxes for the affected years. Such tax obligations would have a Material Adverse
Effect on the Company. Unless eligible for limited relief, if the Company
failed, or revoked its election, to qualify as a REIT, the Company would not be
eligible to elect again to be treated as a REIT before the fifth taxable year
after the year of such termination or revocation.
Recent Developments Regarding Liquidity
On January 31, 2000, the Company and all of the lenders under a prior credit
agreement entered into the Amended Credit Agreement, which amended and restated
the $1.2 billion credit agreement (the "Bank Credit Agreement") the Company
entered into at the time of the 1998 Spin Off. See "Note 4--Bank Credit
Facility."
Other Recent Developments
Tenant Bankruptcies and Defaults
Certain of the Company's tenants, other than Vencor, have filed for protection
under the Bankruptcy Code. These tenants include: Sun Healthcare Group, Inc. and
a number of its subsidiaries (collectively, "Sun"), and Integrated Health
Services, Inc. and a number of its subsidiaries (collectively, "IHS"). Under the
Bankruptcy Code, a tenant may seek either to reject or assume the Company's
leases. If a tenant rejects the leases, then the Company will have to locate a
substitute tenant or operator for the facilities whose leases were rejected.
There can be no assurance that the Company would be able to locate satisfactory
substitute tenants or operators for such facilities on terms that are acceptable
to the Company. If the Company does not locate substitute tenants or operators
on terms acceptable to the Company, then the Company, without obligation to do
so, may elect to assume operations at the facilities, sell the facilities or
close the facilities.
On July 18, 2000, IHS filed a motion in the IHS bankruptcy proceeding to
reject a lease with the Company for a nursing facility in Marne, Michigan. The
current aggregate annual base rental for the facility is approximately $0.4
million. The hearing on the motion as it relates to this lease has been
adjourned until further notice and to date no hearing date has been scheduled.
To date, the Company has not located a substitute tenant for the nursing
facility. If the bankruptcy court approves the IHS motion to reject the lease
and the Company does not locate a substitute tenant for the facility on terms
that are acceptable to the Company, the Company may elect to assume operations
at the facility, sell the facility or take certain other action relative to the
facility. There can be no assurance that the Company will locate a satisfactory
substitute tenant for the facility on terms acceptable to the Company. The
Company's ability to engage in certain of these transactions is restricted by
the terms of the Amended Credit Agreement. Any such transaction would likely
require the consent of the "Required Lenders" under the Amended Credit
Agreement, and there can be no assurance that such consent would be obtained. On
August 25, 2000, the Company filed a general claim (as amended on August 28,
2000) against IHS in the bankruptcy proceeding for, among other things, the
fees, costs, expenses and damages resulting from any rejection of the Company's
lease. Applicable bankruptcy law may limit the amount of any such recovery
against IHS. There can be no assurance the Company will prevail in a claim
against IHS or that IHS will have sufficient assets to satisfy such claim. The
Company is continuing to evaluate what effect, if any, IHS's actions may have on
the carrying value of this facility.
Integrated Health Services of Naples, Inc. ("IHS of Naples"), an affiliate of
IHS, leases a nursing facility in Las Vegas, Nevada from the Company. The
aggregate annual base rental under the lease is approximately $0.3 million. IHS
of Naples has not filed for protection under the Bankruptcy Code. IHS of Naples
failed to make the monthly rental payments for September and October, 2000 for
this facility. Notices of these payment defaults have been issued to IHS of
Naples. There can be no assurance that IHS of Naples will pay the September or
October, 2000 rent or any future rental payments due under the lease. The
Company is currently evaluating what effect IHS's actions will have on the
carrying value of this facility, if any. No adjustments have been recorded in
the accompanying Condensed Consolidated Financial Statements as a result of
these developments.
13
<PAGE>
On November 1, 2000, the Company sold its 99 bed nursing facility in Toledo,
Ohio, which was leased to and operated by Sun, to the Franciscan Services
Corporation for approximately $4.0 million. In connection with the sale of this
facility, the Company and Sun entered into a termination of lease agreement
terminating the lease between the Company and Sun for this facility. The
Toledo, Ohio nursing facility was the only Company facility leased to Sun.
Third Party Leases
In connection with the 1998 Spin Off, the Company assigned its former third
party lease obligations (i.e., leases under which an unrelated third party is
the landlord) (the "Third Party Leases") as a tenant or as a guarantor of tenant
obligations to Vencor. The lessors of these properties may claim that the
Company remains liable on the Third Party Leases assigned to Vencor. Under the
terms of the Agreement of Indemnity--Third Party Leases entered into at the time
of the 1998 Spin Off (the "Agreement of Indemnity--Third Party Leases"), Vencor
and certain of its subsidiaries have agreed to indemnify and hold the Company
harmless from and against all claims against the Company arising out of the
Third Party Leases assigned by the Company to Vencor. Either prior to or
following the 1998 Spin Off, the tenant's rights under a subset of the Third
Party Leases were assigned or sublet to unrelated third parties (the "Subleased
Third Party Leases"). The Company believes that three of the third party
subtenants under the Subleased Third Party Leases, Health Enterprises of
Michigan, Inc. ("HEM"), Lenox Healthcare, Inc. and its subsidiaries
(collectively, "Lenox") and IHS have filed for protection under the Bankruptcy
Code. If Vencor or a third party subtenant is unable to satisfy the obligations
under any Third Party Lease assigned by the Company to Vencor and sublet or
assigned to such third party subtenant, and if the lessors prevail in a claim
against the Company under the Third Party Leases, then the Company may be liable
for the payment and performance of the obligations under any such Third Party
Lease. In that event, the Company may be entitled to receive revenues from those
properties that would mitigate the costs incurred in connection with the
satisfaction of such obligations. Pursuant to the Rent Stipulation, Vencor has
agreed to fulfill its obligations under the Agreement of Indemnity--Third Party
Leases during the period in which the Rent Stipulation is in effect, and, except
for disputes with Health Care Property Investors discussed below, has to date
performed its obligations. However, there can be no assurance that Vencor will
continue to pay, indemnify and defend the claims or that Vencor will have
sufficient assets, income and access to financing to enable it to satisfy such
claims.
On October 23, 2000, Lenox filed its second amended joint chapter 11 plan of
reorganization (the "Lenox Plan of Reorganization") and related disclosure
statement. The Company and Ventas Realty had previously filed claims against
Lenox for, among other things, claims for indemnification arising out of certain
Subleased Third Party Leases (collectively, the "Lenox Claims"). The Lenox Plan
of Reorganization provides for a potential settlement of any and all claims that
have been or might have been asserted by Vencor against Lenox and any and all
claims that Lenox have or may assert against Vencor (the "Vencor Settlement").
The Vencor Settlement provides, among other things, for the termination of a
Subleased Third Party Lease by Lenox of a healthcare facility in San Rafael,
California, the assumption of three other Subleased Third Party Leases by Lenox
relating to healthcare facilities in Crane, Missouri, Kimberling City, Missouri
and Independence, Missouri, and the resolution of the claims of Vencor against
Lenox arising out of, among other things, the rejection of three other Subleased
Third Party Leases by Lenox relating to healthcare facilities in San Rafael,
California, Evansville, Indiana and Kansas City, Missouri.
The Company has initiated discussions with Lenox regarding the treatment of
Subleased Third Party Leases under the Vencor Settlement and the Lenox Claims
and the release by Lenox of any and all claims that Lenox has or may assert
against the Company. There can be no assurance that the Company will be able to
reach an agreement with Lenox. In accordance with the Spin Agreements and the
Rent Stipulation, the Company has issued written demand to Vencor for payment,
performance, indemnification and defense for any and all claims arising out of
the Third Party Leases that are the subject of any Subleased Third Party Lease
that are rejected by Lenox. There can be no assurance that Vencor will pay,
indemnify and defend these claims or that Vencor will have sufficient assets,
income and access to financing to enable it to satisfy these claims.
IHS filed a motion with the bankruptcy court in the IHS bankruptcy proceeding
seeking approval of the rejection of a Subleased Third Party Lease by IHS of a
nursing facility in Harlingen, Texas. The hearing on the motion as it relates
to this lease has been adjourned until further notice and to date no hearing has
been scheduled. The estimated total remaining rental payments for this nursing
facility are approximately $3.4 million. If the motion for the rejection of the
Subleased Third Party Lease is approved by the IHS bankruptcy court, Vencor has
advised the Company that Vencor will, in accordance with its obligations under
the Spin Agreements and the Rent Stipulation, assume operation of this nursing
facility and satisfy the obligations under the related Third Party Lease.
However, there can be no assurance that Vencor will perform the obligations
under this Third Party Lease or that Vencor will have sufficient assets, income
and access to financing to enable it to satisfy such obligations.
14
<PAGE>
The Company received demands for payment from Health Care Property Investors
("HCPI") by letters dated October 19, 1999, February 4, 2000, March 7, 2000,
April 19, 2000 and July 7, 2000 for obligations alleged to be due under certain
Third Party Leases. Certain of these obligations have either been satisfied by
Vencor or otherwise resolved between HCPI and Vencor. Currently, the aggregate
amount alleged to be due to HCPI is approximately $2.8 million, excluding
amounts for deferred maintenance issues. In addition, by letter dated February
9, 2000, HCPI notified the Company and Vencor that HCPI intends to exercise its
right under certain Third Party Leases to require the Company or Vencor to
purchase two facilities owned by HCPI (one in Evansville, Indiana and one in
Kansas City, Missouri). The two facilities have allegedly been closed and HCPI
has stated that if the facilities were not reopened within the required period
of time, HCPI would demand that the Company or Vencor purchase the facility not
so reopened for the greater of the minimum repurchase price or the fair value.
Vencor has advised the Company that Vencor will not reopen the Evansville,
Indiana facility. However, Vencor and HCPI entered into an agreement (the
"Evansville Agreement") resolving the matters relating to the Evansville,
Indiana facility, which includes the termination of the Third Party Lease and
the repurchase requirement in exchange for an agreed upon payment by Vencor. At
a hearing on August 9, 2000, the Vencor bankruptcy court approved the Evansville
Agreement. The transaction contemplated by the Evansville Agreement was
consummated on or about August 10, 2000. Vencor advised the Company and HCPI
that the Kansas City facility was reopened on April 21, 2000. By letter dated
October 6, 2000, counsel for HCPI advised the Company that the reopening of the
Kansas City facility on April 21, 2000 was not timely under the terms of the
Third Party Lease for this facility and reasserted the demand that the Company
repurchase the facility in accordance with the terms of the Third Party Lease.
HCPI maintains that the repurchase price for this facility is $8.5 million.
In accordance with the terms of the Spin Agreements and the Rent Stipulation,
the Company has issued written demand to Vencor for payment, performance,
indemnification and defense of the claims, obligations and allegations asserted
by HCPI. There can be no assurance that Vencor will pay, indemnify and defend
these claims or that Vencor will have sufficient assets, income and access to
financing to enable it to satisfy such claims.
No adjustments or provisions for liability, if any, resulting from the matters
discussed above has been recorded in the Condensed Consolidated Financial
Statements as of September 30, 2000.
NOTE 4--BANK CREDIT FACILITY
On January 31, 2000, the Company and the lenders under the Bank Credit
Agreement entered into the Amended Credit Agreement, which amended and restated
the Bank Credit Agreement. Under the Amended Credit Agreement, borrowings bear
interest at an applicable margin over an interest rate selected by the Company.
Such interest rate may be either (a) the Base Rate, which is the greater of (i)
the prime rate or (ii) the federal funds rate plus 50 basis points, or (b)
LIBOR. Borrowings under the Amended Credit Agreement are comprised of: (1) a
$25.0 million revolving credit line (the "Revolving Credit Line") that expires
on December 31, 2002, which bears interest at either LIBOR plus 2.75% or the
Base Rate plus 1.75%; (2) a $200.0 million term loan due December 31, 2002 (the
"Tranche A Loan"), which bears interest at either LIBOR plus 2.75% or the Base
Rate plus 1.75%; (3) a $300.0 million term loan due December 31, 2005 (the
"Tranche B Loan"), which bears interest at either LIBOR plus 3.75% or the Base
Rate plus 2.75%; and (4) a $473.4 million term loan due December 31, 2007 (the
"Tranche C Loan"), which bears interest at either LIBOR plus 4.25% or the Base
Rate plus 3.25%. The interest rate on the Tranche B Loan will be reduced by .50%
(50 basis points) once $150.0 million of the Tranche B Loan has been repaid.
The Amended Credit Agreement requires the following amortization: (a) with
respect to the Tranche A Loan, (i) $50.0 million of the Tranche A Loan was paid
at closing on January 31, 2000, (ii) $50.0 million is due within 30 days after
Vencor's plan of reorganization becomes effective (the "Vencor Effective Date"),
and (iii) thereafter all Excess Cash Flow (as defined in the Amended Credit
Agreement) of the Company will be applied to the Tranche A Loan until $200.0
million in total has been paid down on the Amended Credit Agreement, with the
balance, if any, due December 31, 2002; (b) with respect to the Tranche B Loan,
(i) after the $50.0 million paydown on the Tranche A Loan to be made within 30
days after the Vencor Effective Date and after consideration of other cash needs
of the Company, a one-time paydown of Excess Cash (as defined in the Amended
Credit Agreement) and (ii) scheduled paydowns of $50.0 million on December 31,
2003 and December 31, 2004, with the balance due December 31, 2005; and (c) with
respect to the Tranche C Loan, no scheduled paydowns with a final maturity of
December 31, 2007. The facilities under the Amended Credit Agreement are pre-
payable without premium or penalty.
The following is a summary of long-term borrowings at September 30, 2000 (In
Thousands):
<TABLE>
<CAPTION>
Amount
-----------
<S> <C>
Tranche A Loan, bearing interest at a rate of LIBOR plus 2.75%
(9.37% at September 30, 2000), due December 31, 2002............................................ $150,000
</TABLE>
15
<PAGE>
<TABLE>
<S> <C>
Tranche B Loan, bearing interest at a rate of LIBOR plus 3.75%
(10.37% at September 30, 2000), due December 31, 2005........................................ 300,000
Tranche C Loan, bearing interest at a rate of LIBOR plus 4.25%
(10.87% at September 30, 2000), due December 31, 2007........................................ 473,368
--------
$923,368
========
The following is a summary of long-term borrowings at December 31, 1999 (In Thousands):
Amount
-----------
Revolving line of credit, bearing interest at a base rate of LIBOR
Plus 2.25% (8.72% to 8.74% at December 31, 1999)............................................. $202,743
Bridge facility loan, bearing interest at a base rate of LIBOR
plus 2.75% (9.23% at December 31, 1999)...................................................... 275,000
Term A Loan, bearing interest at a base rate of LIBOR plus 2.25%
(8.74% at December 31, 1999)................................................................. 181,818
Term B Loan, bearing interest at a base rate of LIBOR plus 2.75%
(9.24% at December 31, 1999)................................................................. 314,682
Other.......................................................................................... 4
--------
$974,247
========
</TABLE>
During the first quarter of 2000, the Company incurred an extraordinary loss
of approximately $4.2 million relating to the write-off of the unamortized
deferred financing costs associated with the Bank Credit Agreement.
On October 29, 1999, in conjunction with the execution of an agreement with
over 95% of the lenders under the Bank Credit Agreement (the "Waiver and
Extension Agreement") regarding the restructuring of the Company's long-term
debt, including the $275.0 million Bridge Loan, the Company paid a $2.4 million
loan waiver fee which was fully amortized over the three month extension period
under the Waiver and Extension Agreement. In connection with the consummation of
the Amended Credit Agreement on January 31, 2000, the Company paid a $7.3
million loan restructuring fee. The $7.3 million fee is being amortized
proportionately over the terms of the related loans.
The Amended Credit Agreement is secured by liens on substantially all of the
Company's real property and any related leases, rents and personal property.
Certain properties are being held in escrow by counsel for the agents under the
Amended Credit Agreement pending the receipt of third party consents and/or
resolution of certain other matters. In addition, the Amended Credit Agreement
contains certain restrictive covenants, including, but not limited to, the
following: (a) until such time that $200.0 million in principal amount has been
paid down, the Company can only pay dividends based on a certain minimum
percentage of its taxable income (currently equal to 95% of its taxable income
for the year ending December 31, 2000 and 90% of its taxable income for years
ending on or after December 31, 2001); however, after $200.0 million in total
principal paydowns, the Company will be allowed to pay dividends for any year in
amounts up to 80% of funds from operations ("FFO"), as defined in the Amended
Credit Agreement; (b) limitations on additional indebtedness, acquisitions of
assets, liens, guarantees, investments, restricted payments, leases, affiliate
transactions and capital expenditures; and (c) certain financial covenants,
including requiring that the Company have (i) $50.0 million in cash and cash
equivalents on hand at the Vencor Effective Date; (ii) no more than $1.1 billion
of total indebtedness on the Vencor Effective Date; and (iii) at least $99.0
million of Projected Consolidated EBITDA, as defined in the Amended Credit
Agreement, for the 270 day period beginning in the first month after the Vencor
Effective Date.
Under the terms of the Preliminary Plan of Reorganization the Company would be
in compliance with the financial covenants contained in the Amended Credit
Agreement if the Vencor Effective Date occurs on or before December 31, 2000.
Under the terms of the Amended Credit Agreement, an event of default is deemed
to have occurred if the Vencor Effective Date does not occur on or before
December 31, 2000. Subject to any defenses available to the Company, if such an
event of default were to occur, the Company could be required to immediately
repay all the indebtedness under the Amended Credit Agreement upon the demand of
the "Required Lenders," as defined in the Amended Credit Agreement. The Company
has initiated discussions with the administrative agent for its lenders under
the Amended Credit Agreement to obtain a waiver or amendment of this covenant.
Under the Amended Credit Agreement, a waiver or amendment of this covenant must
be approved by lenders holding (in the aggregate) greater than 50% of the total
credit exposure under the Amended Credit Agreement. The Company believes that
the holders of a majority of the Vencor bank indebtedness also hold a
substantial portion of the total credit exposure under the Amended Credit
Agreement. There can be no assurance (i) that a plan of reorganization for
Vencor will become effective on or before December 31, 2000, (ii) that the
Company will obtain a waiver or
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amendment of the covenant if a plan of reorganization for Vencor is not
effective on or before December 31, 2000, (iii) that the terms of such a waiver
or amendment would not have a Material Adverse Effect on the Company, or (iv)
that the failure to obtain such a waiver or amendment would not have a Material
Adverse Effect on the Company.
The Amended Credit Agreement does not contain any financial covenants that are
applicable to the Company prior to the Vencor Effective Date, and provides,
among other things, that no action taken by any person in the Vencor bankruptcy
case (other than by the Company and its affiliates) shall be deemed to
constitute or result in a "Material Adverse Effect," as defined in the Amended
Credit Agreement. In addition, the Amended Credit Agreement provides that if the
Company is in compliance with its financial covenants and the covenant relating
to releases in the Vencor bankruptcy on the Vencor Effective Date, no event or
condition arising primarily from the Vencor plan of reorganization shall be
deemed to have caused a "Material Adverse Effect," as defined in the Amended
Credit Agreement, to have occurred.
The Company has an interest rate swap agreement with a notional principal
amount of $875.0 million, under which the Company pays a fixed rate at 5.985%
and receives LIBOR (floating rate). The terms of the interest rate swap
agreement require that the Company make a cash payment or otherwise post
collateral to the counterparty if the fair value loss to the Company exceeds
certain levels. The threshold levels vary based on the relationship between the
Company's debt obligations and the tangible fair value of its assets as defined
in the Bank Credit Agreement. As of September 30, 2000, no collateral was
required to be posted under the interest rate swap agreement.
On August 4, 1999, the Company entered into an agreement with the interest
rate swap agreement counterparty to shorten the maturity of the interest rate
swap agreement from December 31, 2007 to June 30, 2003, in exchange for a
payment in 1999 from the counterparty to the Company of $21.6 million. So long
as the Company has debt in excess of $750.0 million, the Company will amortize
the $21.6 million payment for financial accounting purposes in future periods
beginning in July 2003 and ending December 2007.
On January 31, 2000, the Company entered into a letter agreement with the
counterparty to the swap agreement for the purpose of amending the swap
agreement. The letter agreement provides that, for purposes of certain
calculations set forth in the swap agreement, the parties agree to continue to
use certain defined terms set forth in the Bank Credit Agreement.
NOTE 5--Litigation
Legal Proceedings Defended and Indemnified by Vencor Under the Spin Agreements
The following litigation and other matters arose from the Company's operations
prior to the 1998 Spin Off or relate to assets or liabilities transferred to
Vencor in connection with the 1998 Spin Off. Under the Spin Agreements, Vencor
agreed to assume the defense, on behalf of the Company, of any claims that (a)
were pending at the time of the 1998 Spin Off and which arose out of the
ownership or operation of the healthcare operations or any of the assets or
liabilities transferred to Vencor in connection with the 1998 Spin Off, or (b)
were asserted after the 1998 Spin Off and which arose out of the ownership and
operation of the healthcare operations or any of the assets or liabilities
transferred to Vencor in connection with the 1998 Spin Off, and to indemnify the
Company for any fees, costs, expenses and liabilities arising out of such
operations (the "Indemnification"). Vencor is presently defending the Company in
the following matters. Under the Rent Stipulation (see "Note 3--Concentration of
Credit Risk and Recent Developments"), Vencor agreed to abide by the
Indemnification and to continue to defend the Company in these and other matters
as required under the Spin Agreements while the Rent Stipulation is in effect.
However, there can be no assurance that the Rent Stipulation will remain in
effect, that Vencor will continue to defend the Company in such matters or that
Vencor will have sufficient assets, income and access to financing to enable it
to satisfy such obligations or its obligations incurred in connection with the
1998 Spin Off. In addition, many of the following descriptions are based
primarily on information included in Vencor's public filings and information
provided to the Company by Vencor. There can be no assurance that Vencor has
provided the Company with complete and accurate information in all instances.
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 putative class action
claims were brought by an alleged stockholder of the Company against the Company
and certain executive officers and directors of the Company. The complaint
alleges that the Company and certain current and former executive officers of
the Company during a specified time frame violated Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, as amended, by, among other things, issuing
to the investing public a series of
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false and misleading statements concerning the Company's current operations and
the inherent value of the Company's common stock. The complaint further alleges
that as a result of these purported false and misleading statements concerning
the Company's revenues and successful acquisitions, the price of the Company's
common stock was artificially inflated. In particular, the complaint alleges
that the Company issued false and misleading financial statements between
February and October of 1997 which misrepresented and understated the impact
that changes in Medicare reimbursement policies would have on the Company's core
services and profitability. The complaint further alleges that the Company
issued a series of materially false statements concerning the purportedly
successful integration of its acquisitions and prospective earnings per share
for 1997 and 1998 which the Company 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. On January 22, 1999 the United States District Court for the Western
District of Kentucky entered a judgment dismissing the action in its entirety as
to all defendants in the case. On April 24, 2000, the United States Court of
Appeals for the Sixth Circuit upheld the District Court's judgment dismissing
the action in its entirety as to all defendants in the case. On July 14, 2000,
the Sixth Circuit granted plaintiffs' motion for rehearing of their appeal en
banc and vacated its earlier decision. The parties have filed en banc briefs
pursuant to the Court's order. Oral argument en banc before the Sixth Circuit
has been set for December 6, 2000. Vencor, on behalf of the Company, is
defending this action vigorously.
Vencor and the Company have been informed by the Department of Justice that
they are the subject of ongoing investigations into various aspects of claims
for reimbursement from government payers, billing practices and various quality
of care issues in the hospitals and nursing facilities formerly operated by the
Company and presently operated by Vencor. These investigations cover the
Company's former healthcare operations prior to the date of the 1998 Spin Off,
and include matters arising out of the qui tam actions described below and
additional potential claims. Certain of the complaints described below name
other defendants in addition to the Company. The United States Department of
Justice, Civil Division filed two proofs of claim in the Vencor bankruptcy court
covering the United States' claims and the qui tam suits. The United States
asserted approximately $1.3 billion, including treble damages, against Vencor in
these proofs of claim. The Department of Justice has informed the Company that
it is the Department of Justice's position that if liability exists in
connection with such investigations or qui tam actions, the Company and Vencor
will be jointly and severally liable for the portion of such claims related to
the period prior to the date of the 1998 Spin Off. Any liability the Company may
incur in connection with these matters will be subject to the Company's rights
under the Indemnification and Vencor's ability and willingness to perform
thereunder.
American X-Rays, Inc. ("AXR") was a subsidiary of the Company prior to the
1998 Spin Off. The Company transferred all of its interest in AXR to Vencor in
the 1998 Spin Off. AXR is the defendant in a civil qui tam lawsuit which was
filed in the United States District Court for the Eastern District of Arkansas
and served on the Company on July 7, 1997. The lawsuit is styled United States
ex rel. Doe v. American X-Ray, Inc., No. LR-C-95-332 (E.D. Ark.). The United
States of America has intervened in the suit which was brought under the Federal
Civil False Claims Act. AXR provided portable X-ray services to nursing
facilities (including those operated by the Company at the time) and other
healthcare providers. The Company acquired an interest in AXR when The Hillhaven
Corporation ("Hillhaven") was merged with and into the Company in September 1995
and purchased the remaining interest in AXR in February 1996. The civil lawsuit
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. In a related criminal investigation, the United States
Attorney's Office for the Eastern District of Arkansas indicted four former
employees of AXR; those individuals were convicted of various fraud related
counts in January 1999. The Company and Vencor have received several grand jury
subpoenas for documents and witnesses, which Vencor, on behalf of the Company
has moved to quash. On May 4, 1999, the United States of America amended its
civil complaint to include Vencor and the Company as defendants. Vencor and the
Company have moved to dismiss the amended complaint. Vencor, on behalf of the
Company, is defending this action vigorously. This case has been
administratively terminated without prejudice pending the outcome of the
settlement discussions among the Department of Justice, the Company and Vencor.
On November 24, 1997, a civil qui tam lawsuit was filed against the Company in
the United States District Court for the Middle District of Florida. This
lawsuit was brought under the Federal Civil False Claims Act and is styled
United States of America, ex rel. Virginia Lee Lanford and Gwendolyne Cavanaugh
v. Vencor, Inc., et al, No. 97-CV-2845. The United States of America intervened
in the lawsuit on May 17, 1999. On July 23, 1999, the United States filed its
amended complaint in the lawsuit. The lawsuit alleges that the Company and
Vencor 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 Vencor's nursing facilities
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and for third party nursing facility operators that the United States of America
claims are not reimbursable costs. The lawsuit involves the Company's former
healthcare operations. The complaint does not specify the amount of damages
claimed by the plaintiffs. The Company disputes the allegations contained in the
complaint and the Company and/or Vencor, on behalf of the Company, intend to
defend this action vigorously.
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, Transitional Hospitals Corporation
("Transitional"), the Company's former subsidiary which was transferred to
Vencor in the 1998 Spin Off, and two unrelated entities, Gambro Healthcare, Inc.
and Dialysis Holdings, Inc., are defendants. This suit alleges that the
defendants violated the Federal Civil False Claims Act and the Anti-Kickback
Statute 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 Anti-
Kickback Statute. 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 Anti-Kickback Statute. Transitional has moved to
dismiss the case. Transitional disputes the allegations in the complaint and is
defending the action vigorously.
On or about January 7, 2000 the United States of America intervened in each of
the following previously sealed (and therefore previously non-public) qui-tam
cases with respect to the claims against the Company and/or Vencor: United
States ex rel. George Mitchell et al. v. Vencor, Inc. et al. (S.D. Ohio); United
States ex rel. Danley v. Medisave Pharmacies, Inc., Hillhaven Corp., and Vencor,
Inc., Civil No. CV-N-96-00170-HDM (D. Nev., Reno Div.); United States ex rel.
Roberts v. Vencor, Inc. et al., Civil Action No. 3:97CV-349-J, (W.D. Kan.)
consolidated with United States ex rel. Meharg, et al. v. Vencor, Inc., et al.,
Civil Action No. 3:98SC-737-H, (M.D. Fla.); United States ex rel. Huff, et. al
v. Vencor, Inc., et al., Civil No. 97-4358 AHM (MCX); United States ex rel.
Brzycki v. Vencor, Inc., Civil No. 97-451-JD; United States, et al., ex rel.,
Phillips-Minks, et al. v. Transitional Hospitals Corp., et al.; United States ex
rel. Harris and Young v. Vencor, Inc., et al., (E.D. Mo.) 4:99CB00842 and Gary
Graham on Behalf of the United States of America v. Vencor Operating, Inc. et
al., (S.D. Fla.). Except for the order in United States ex rel. Harris and
Young, which is described below, the order granting the United States' motions
to intervene in these lawsuits state that the United States is intervening for
the purpose of representing the United States' interests in the Vencor
bankruptcy proceeding and to effectuate any settlement reached between the
United States and Vencor and/or the Company. The courts have ordered these
complaints unsealed, but the Company has not been formally served with a
complaint in any of these lawsuits. The deadline for the service of the
complaints in most of these cases is currently scheduled to expire in November,
2000. The Company and Vencor have requested that the Department of Justice
petition the applicable courts to extend the period of time in which the
complaints in these cases must be served on the Company. The Department of
Justice has indicated its intention to seek at least a 90 day extension of this
time period from the courts in each of these lawsuits. There can be no
assurances that such extensions will be obtained. Each of these lawsuits is
described in more detail immediately below.
United States ex rel. George Mitchell et al. v. Vencor, Inc. et al. (S.D.
Ohio), filed on August 13, 1999, was brought under the Federal Civil False
Claims Act. The lawsuit alleges that the Company and its former subsidiaries,
Vencare, Inc. ("Vencare") and Vencor Hospice, Inc. (both of which were
transferred to Vencor in the 1998 Spin Off), submitted false statements to the
Medicare program for, among other things, reimbursement for costs for patients
who were not "hospice appropriate." The complaint alleges damages in excess of
$1.0 million. The Company disputes the allegations contained in the complaint.
If the United States and Vencor and/or the Company do not reach a settlement or
should the complaint in this lawsuit be served on the Company, the Company
and/or Vencor, on behalf of the Company, intends to defend this action
vigorously.
In United States ex rel. Danley v. Medisave Pharmacies, Inc., Hillhaven Corp.,
and Vencor, Inc., Civil No. CV-N-96-00170-HDM (D. Nev., Reno Div.), filed on
March 15, 1996, it is alleged that Medisave Pharmacies, Inc. ("Medisave"), a
former subsidiary of the Company and now a subsidiary of Vencor, (a) charged the
Medicare program for unit dose drugs when bulk drugs were administered and
charged skilled nursing facilities more for the same drugs for Medicare patients
than for non-Medicare patients; (b) improperly claimed special dispensing fees
that it was not entitled to under Medicaid; and (c) recouped unused drugs from
skilled nursing facilities and returned these drugs to its stock without
crediting Medicare or Medicaid, all in violation of the Federal Civil False
Claims Act. It also alleged that Medisave had a policy of offering kickbacks
such as free equipment to skilled nursing facilities to secure and maintain
their business. The complaint seeks treble damages, other unspecified damages,
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civil penalties, attorneys' fees and other costs. The Company disputes the
allegations contained in the complaint. If the United States and Vencor and/or
the Company do not reach a settlement or should the complaint in this lawsuit be
served on the Company, the Company and/or Vencor, on behalf of the Company,
intends to defend this action vigorously.
In the lawsuits styled United States ex rel. Roberts v. Vencor, Inc. et al.,
Civil Action No. 3:97CV-349-J (W.D. Kan.), filed on June 25, 1996, consolidated
with United States ex rel. Meharg, et al. v. Vencor, Inc., et al., Civil Action
No. 3:98SC-737-H, (M.D. Fla.), filed on June 4, 1998, it is alleged that the
Company, Vencor and Vencare, among others, submitted and conspired to submit
false claims to the Medicare program in connection with their purported
provision of respiratory therapy services to skilled nursing facility residents.
The Company and Vencare 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 its therapists. It is further alleged that the Company and
Vencare 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 facilities 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 contained in the complaint. If the United States and Vencor
and/or the Company do not reach a settlement or should the complaint in this
lawsuit be served on the Company, the Company and/or Vencor, on behalf of the
Company, intends to defend this action vigorously.
The Company is a defendant in the case captioned United States ex rel. Huff,
et al. v. Vencor, Inc., et al., Civil No. 97-4358 AHM(MCX) filed in the United
States District Court for the Central District of California on June 13, 1997.
The complaint alleges, among other things, that the defendants violated the
Federal Civil False Claims Act by submitting false claims to Medicare, Medicaid
and CHAMPUS programs by allegedly (a) falsifying patient bills and submitting
the bills to Medicare, Medicaid and CHAMPUS programs, (b) submitting bills for
intensive and critical care not actually administered to patients, (c) the
falsifying of patient charts in relation to the billing, (d) charging for
physical therapy services allegedly not provided and pharmacy services allegedly
provided by non-pharmacists, and (e) billing for sales calls made by nurses to
prospective patients. The complaint further alleges the improper establishment
of TEFRA rates. The complaint seeks treble damages, other unspecified damages,
civil penalties, attorney's fees and other costs. The Company disputes the
allegations contained in the complaint. If the United States and Vencor and/or
the Company do not reach a settlement or should the complaint in this lawsuit be
served on the Company, the Company and/or Vencor, on behalf of the Company,
intends to defend this action vigorously.
The Company is a defendant in the proceeding captioned United States ex rel.
Brzycki v. Vencor, Inc., Civil No. 97-451-JD, filed in the United States
District Court for the District of New Hampshire on September 8, 1997. In this
lawsuit the Company is accused of knowingly violating the Federal Civil False
Claims Act by submitting and conspiring to submit false claims to the Medicare
program. The complaint includes allegations that the Company (a) fabricated
diagnostic codes by ordering and providing medically unnecessary ancillary
services (such as respiratory therapy), (b) changed referring physicians'
diagnoses in order to qualify for Medicare reimbursement; (c) billed for
products or services not received or not received in the manner billed, and (d)
paid illegal kickbacks to referring health care professionals in the form of
medical consulting service agreements as an alleged inducement to refer patients
in violation of the Anti-Kickback Act and Stark laws. The complaint seeks
unspecified damages, civil penalties, attorneys' fees and other costs. The
Company disputes the allegations contained in the complaint. If the United
States and Vencor and/or the Company do not reach a settlement or should the
complaint in this lawsuit be served on the Company, the Company and/or Vencor,
on behalf of the Company, intends to defend this action vigorously.
In United States, et al., ex rel., Phillips-Minks, et al. v. Transitional
Hospitals Corp., et al., filed in the Southern District of California on July
23, 1998, it is alleged that the defendants, including Transitional, submitted
and conspired to submit false claims and statements to Medicare, Medicaid, and
other federally and state funded programs during a period commencing in 1993.
The complaint also includes certain other state law claims. The conduct
complained of allegedly violates the Federal 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. Defendants
allegedly submitted improper and erroneous claims to Medicare, Medicaid and
other programs, for improper, unnecessary and false services, excess collections
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
reimburse at a higher level, and improperly allocating hospital insurance
expenses. In addition, the complaint avers that defendants were inconsistent in
their reporting of cost report data, paid out kickbacks to increase patient
referrals to defendant hospitals, and incorrectly
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reported employee compensation resulting in inflated employee 401(k)
contributions. The complaint seeks unspecified damages and expenses. The United
States has informed the Company that it has withdrawn its intervention in this
case and declined the case. The Company disputes the allegations contained in
the complaint. If the United States and Vencor and/or the Company do not reach a
settlement or should the complaint in this lawsuit be served on Transitional,
the Company and/or Vencor, on behalf of the Company, intends to defend this
action vigorously.
The lawsuit styled United States ex rel. Harris and Young v. Vencor, Inc., et
al., 4:99CB00842 (E.D. Mo.), filed on May 25, 1999, was brought under the
Federal Civil False Claims Act. The lawsuit alleges that the defendants
submitted or cause to be submitted false claims for reimbursement to the
Medicare and CHAMPUS programs. Vencare, the Company's former subsidiary and a
current subsidiary of Vencor, allegedly (a) over billed for respiratory therapy
services, (b) rendered medically unnecessary treatment, and (c) falsified
supply, clinical and equipment records. The defendants also allegedly encouraged
or instructed therapists to falsify clinical records and over prescribe therapy
services. The complaint seeks treble damages, other unspecified damages, civil
penalties, attorneys' fees and other costs. By order of the court entered on
March 23, 2000, this case was dismissed without prejudice as to the United
States and with prejudice as to all other plaintiffs.
In Gary Graham on Behalf of the United States of America v. Vencor Operating,
Inc. et al., (S.D. Fla.), filed on or about June 8, 1999, it is alleged that the
defendants, including the Company, presented or caused to be presented false or
fraudulent claims for payment to the United States under the Medicare program in
violation of, among other things, the Federal Civil False Claims Act. The
complaint claims that Medisave, a former subsidiary of the Company, which was
transferred to Vencor in the 1998 Spin Off, systematically overcharged 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 contained in the complaint. If the United
States and Vencor and/or the Company do not reach a settlement or should the
complaint in this lawsuit be served on the Company, the Company and/or Vencor,
on behalf of the Company, intends to defend this action vigorously.
If the Department of Justice investigations and the qui tam claims were
ultimately decided in a manner adverse to the Company, such adverse decisions
could have a Material Adverse Effect on the Company. Although the Company
believes it has numerous good faith, valid legal and factual defenses to the
Department of Justice and qui tam claims, the Company and Vencor continue to be
engaged in discussions with the Department of Justice regarding a settlement of
the investigations and the qui tam actions. The United States has intervened in
the Mitchell, Danley, Meharg, Roberts, Bryzcki Huff and Graham qui tam lawsuits
described above for the purpose of facilitating any such settlement. Such a
settlement, if reached, would resolve all of the actions in which the Department
of Justice has intervened and other claims by the Department of Justice, and
could involve the payments of amounts by the Company that might not be subject
to Indemnification and that would have a Material Adverse Effect on the Company.
There can be no assurance that the Company, Vencor and the Department of Justice
will reach a settlement relative to all or any such claims.
Vencor is a party to certain legal actions and regulatory investigations
arising in the normal course of its business. Neither the Company nor Vencor is
able to predict the ultimate outcome of pending litigation and regulatory
investigations. In addition, there can be no assurance that the United States
Health Care Financing Administration ("HCFA") or other regulatory agencies will
not initiate additional investigations related to Vencor's business 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 Vencor's liquidity, financial position or results of
operations, which in turn could have a Material Adverse Effect on the Company.
The Company is a party to certain legal actions and regulatory investigations
which arise from the normal course of its prior healthcare operations. The
Company is unable to predict the ultimate outcome of pending litigation and
regulatory investigations. In addition, there can be no assurance that other
regulatory agencies will not initiate additional investigations related to the
Company's prior healthcare business 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. The Company is party to various other lawsuits, both as defendant
and plaintiff, arising in the normal course of business from the Company's prior
healthcare operations which are being defended by Vencor under the
Indemnification. It is the opinion of management that, except as set forth in
this Note 5, the disposition of these other lawsuits will not, individually or
in the aggregate, have a Material Adverse Effect on the Company. If management's
assessment of the Company's liability with respect to these actions is
incorrect, such actions could have a Material Adverse Effect on the Company.
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Unasserted Claims--Potential Liabilities Due to Fraudulent Transfer
Considerations, Legal Dividend Requirements and Other Claims
The Company
The 1998 Spin Off, including the simultaneous distribution of the Vencor
common stock to the Ventas stockholders (the "Distribution"), is subject to
review under fraudulent conveyance laws. Under these laws, if a court in a
lawsuit by an unpaid creditor or a representative of creditors (such as a
trustee or debtor-in-possession in bankruptcy of the Company or any of its
respective subsidiaries) were to determine that, as of the 1998 Spin Off, the
Company did not receive fair consideration or reasonably equivalent value for
distributing the stock distributed in the 1998 Spin Off and, at the time of the
1998 Spin Off, the Company or any of its subsidiaries (a) was insolvent or was
rendered insolvent, (b) had unreasonably small capital with which to carry on
its business and all businesses in which it intended to engage, or (c) intended
to incur, or believed it would incur, debts beyond its ability to repay such
debts as they would mature, then such court could among other things order the
holders of the stock distributed in the 1998 Spin Off to return the value of the
stock and any dividends paid thereon and/or invalidate, in whole or in part, the
1998 Spin Off as a fraudulent conveyance.
Vencor
Although no claims have been formally asserted, legal counsel for Vencor and
certain of its creditors have raised questions relating to potential fraudulent
conveyance or obligation issues and other claims relating to the 1998 Spin Off.
If a court in a lawsuit by Vencor or a representative of Vencor's creditors were
to determine that, as of the 1998 Spin Off, Vencor did not receive fair
consideration or reasonably equivalent value for the liabilities it assumed
(such as the Master Leases or the Indemnification obligation), and, at the time
of the 1998 Spin Off, Vencor (a) was insolvent or was rendered insolvent, (b)
had unreasonably small capital with which to carry on its business and all
businesses in which it intended to engage, or (c) intended to incur, or believed
it would incur, debts beyond its ability to repay such debts as they would
mature, then such court could among other things void some or all of such
liabilities. At the time of the 1998 Spin Off, the Company obtained an opinion
from an independent third party that addressed issues of Vencor's solvency and
adequate capitalization. Nevertheless, if a fraudulent conveyance or obligation
claim or other claim is ultimately asserted by Vencor, its creditors, or others,
the ultimate outcome of any such claim cannot presently be determined. The
Company intends to defend these claims vigorously if they are asserted in a
court, arbitration or mediation proceeding. The Company will require that the
potential claims of Vencor relating to the 1998 Spin Off be released in a Vencor
plan of reorganization. However, there can be no assurance that Vencor will be
successful in achieving a plan of reorganization or that such releases will be
included in a Vencor plan of reorganization which may be confirmed. If these
claims were to prevail, it could have a Material Adverse Effect on the Company.
Vencor previously filed a motion with the Delaware bankruptcy court seeking
approval of the Ninth DIP Amendment. Under the Ninth DIP Amendment, the
proceeds of the DIP facility may be used to fund, among other things, Vencor's
expenses in any litigation against the Company commencing before September 30,
2000 relating to the Spin Agreements and/or the 1998 Spin Off. In connection
with the ongoing discussions among Vencor, Vencor's creditors and the Company,
Vencor has postponed the hearing of the motion for approval of the Ninth DIP
Amendment until November 9, 2000. See "Note 3--Concentration of Credit Risk and
Recent Developments--Recent Developments Regarding Vencor."
Legal Dividend Requirements
In addition, the 1998 Spin Off is subject to review under state corporate
distribution and dividend statutes. Under Delaware law, a corporation may not
pay a dividend to its stockholders if (a) the net assets of the corporation do
not exceed its capital, unless the amount proposed to be paid as a dividend is
less than the corporation's net profits for the current and/or preceding fiscal
year in which the dividend is to be paid, or (b) the capital of the corporation
is less than the aggregate amount allocable to all classes of its preferred
stock.
The Company believes that (a) the Company and each of its subsidiaries were
solvent (in accordance with the foregoing definitions) at the time of 1998 Spin
Off, were able to repay their debts as they matured following the 1998 Spin Off
and had sufficient capital to carry on their respective businesses and (b) the
1998 Spin Off was consummated entirely in compliance with Delaware law. There is
no certainty, however, that a court would reach the same conclusions in
determining whether the Company was insolvent at the time of, or after giving
effect to, the 1998 Spin Off or whether lawful funds were available for the 1998
Spin Off.
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The Spin Agreements
The Spin Agreements provide for the allocation, immediately prior to the 1998
Spin Off, of certain debt of the Company. Further, pursuant to the Spin
Agreements, from and after the date of the 1998 Spin Off, each of the Company
and Vencor is responsible for the debts, liabilities and other obligations
related to the businesses which it owns and operates following the consummation
of the 1998 Spin Off. It is possible that a court would disregard the allocation
agreed to among the parties and require the Company or Vencor to assume
responsibility for obligations allocated to the other, particularly if the other
were to refuse or to be unable to pay or perform the subject allocated
obligations.
No provision for liability, if any, resulting from the aforementioned
litigation has been made in the financial statements at September 30, 2000.
Other Legal Proceedings
The Company is a plaintiff in an action seeking a declaratory judgment and
damages entitled Ventas Realty, Limited Partnership et al. v. Black Diamond CLO
1998-1 Ltd., et al., Case No. 99C107076, filed November 22, 1999 in the Circuit
Court of Jefferson County, Kentucky. Two of the three defendants in that action,
Black Diamond International Funding, Ltd. and BDC Finance, LLC (collectively
"Black Diamond"), have asserted counterclaims against the Company under theories
of breach of contract, tortious interference with contract and abuse of process.
These counterclaims allege, among other things, that the Company wrongfully, and
in violation of the terms of the Bank Credit Agreement, (a) failed to recognize
an assignment to Black Diamond of certain notes issued under the Bank Credit
Agreement, (b) failed to issue to Black Diamond new notes under the Bank Credit
Agreement, and (c) executed the Waiver and Extension Agreement between the
Company and its lenders. The counterclaims further claim that the Company acted
tortiously in commencing the action against the defendants. The counterclaims
specifically allege that the foregoing actions wrongfully interfered with Black
Diamond's profitable ongoing business relations with a third party and seek
damages of $11,796,875 (the principal amount of the Company's Bridge Loan under
the Bank Credit Agreement claimed to have been held by Black Diamond), plus
interest, costs, and fees and additional unspecified amounts to be proven at
trial; in addition Black Diamond is seeking a declaration that the Waiver and
Extension Agreement is void and unenforceable.
On March 9, 2000, the defendants filed a motion for summary judgment on the
Company's claims, contending that all such claims were released by the Company
as part of the Amended Credit Agreement, to which defendants Black Diamond CLO
1998-1 Ltd. and Black Diamond International Funding Ltd. (but not defendant BDC
Finance LLC) were signatories. By opinion and order entered May 9, 2000, the
Jefferson Circuit Court denied the defendants' motion for summary judgment. The
Company disputes the material allegations contained in Black Diamond's
counterclaims and the Company intends to pursue its claims and defend the
counterclaims vigorously.
Under the terms of the Amended Credit Agreement, a lender may assign all or
any portion of its indebtedness under the Amended Credit Agreement with prior
written consent of the Company which consent shall not be unreasonably withheld.
On September 12, 2000, the Company issued written notice that the Company would
not consent to two separate requests for assignments by lenders under the
Amended Credit Agreement. The Company believes it withheld consent to these
assignments on reasonable grounds. The lenders have objected in writing to the
Company's failure to consent to the proposed assignments. The Company intends
to vigorously defend its position to withhold consent to the assignments
proposed by these lenders.
The Company is party to various lawsuits arising in the normal course of the
Company's business. It is the opinion of management that, except as set forth
in this Note 5, the disposition of these lawsuits will not, individually or in
the aggregate, have a Material Adverse Effect on the Company. If management's
assessment of the Company's liability with respect to these actions is incorrect
such lawsuits could have a Material Adverse Effect on the Company.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Cautionary Statements
Forward Looking Statements
This Form 10-Q includes forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). All statements regarding the Company's and its subsidiaries'
expected future financial position, results of operations, cash flows, funds
from operations, dividends and dividend plans, financing plans, business
strategy, budgets, projected costs, capital expenditures, competitive positions,
growth opportunities, expected lease income, continued qualification as a real
estate investment trust, plans and objectives of management for future
operations and statements that include words such as "anticipate," "believe,"
"plan," "estimate," "expect," "intend," "may," "could," and other similar
expressions are forward-looking statements. Such forward-looking statements are
inherently uncertain, and stockholders must recognize that actual results may
differ from the Company's expectations. The Company does not undertake any duty
to update such forward looking statements.
Actual future results and trends for the Company may differ materially
depending on a variety of factors discussed in this Form 10-Q and elsewhere in
the Company's filings with the Securities and Exchange Commission (the
"Commission"). Factors that may affect the plans or results of the Company
include, without limitation, (a) the treatment of the Company's claims in the
chapter 11 cases of its primary tenant, Vencor, Inc. ("Vencor") and certain
affiliates, as well as certain of its other tenants, (b) the ability and
willingness of Vencor to continue to meet and/or honor its obligations under the
Spin Agreements (as defined below), including, without limitation, the
obligation to indemnify and defend the Company for all litigation and other
claims relating to the health care operations and other assets and liabilities
transferred to Vencor in the 1998 Spin Off, (c) the ability of Vencor and the
Company's other operators to maintain the financial strength and liquidity
necessary to satisfy their respective obligations and duties under the leases
and other agreements with the Company, and their existing credit agreements, (d)
the Company's success in implementing its business strategy, (e) the nature and
extent of future competition, (f) the extent of future health care reform and
regulation, including cost containment measures and changes in reimbursement
policies and procedures, (g) increases in the cost of borrowing for the Company,
(h) the ability of the Company's operators to deliver high quality care and to
attract patients, (i) the results of litigation affecting the Company, (j) the
results of the settlement discussions Vencor and Ventas have been engaged in
with the federal government seeking to resolve federal civil and administrative
claims against them arising from the participation of Vencor facilities in
various federal health benefit programs, (k) changes in general economic
conditions and/or economic conditions in the markets in which the Company may,
from time to time, compete, (l) the ability of the Company to pay down,
refinance, restructure, and/or extend its indebtedness as it becomes due and to
amend certain provisions of its Amended Credit Agreement (as defined below) that
could require the Company to repay all of its indebtedness under the Amended
Credit Agreement if Vencor does not emerge from bankruptcy by December 31, 2000,
and (m) the ability of the Company to maintain its qualification as a real
estate investment trust. Many of such factors are beyond the control of the
Company and its management.
Vencor Information
Vencor is subject to the reporting requirements of the Commission and is
required to file with the Commission annual reports containing audited financial
information and quarterly reports containing unaudited financial information.
The information related to Vencor provided in this Form 10-Q is derived from
filings made with the Commission or other publicly available information, or has
been provided by Vencor. The Company has not verified this information either
through an independent investigation or by reviewing Vencor's public filings.
The Company has no reason to believe that such information is inaccurate in any
material respect, but there can be no assurance that all such information is
accurate. The Company is providing this data for informational purposes only,
and the reader of this Form 10-Q is encouraged to obtain Vencor's publicly
available filings from the Commission.
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Background Information
Ventas, Inc. ("Ventas" or the "Company") is a Delaware corporation that
qualified as a real estate investment trust ("REIT") under the Internal Revenue
Code of 1986, as amended, beginning with the tax year ending December 31, 1999.
Although the Company intends to continue to qualify as a REIT for the tax year
ending December 31, 2000 and subsequent tax years, it is possible that economic,
market, legal, tax or other considerations may cause the Company to fail or
elect not to continue to qualify as a REIT in any such tax year. The Company
owns or leases 45 hospitals (comprised of two acute care hospitals and 43 long-
term acute care hospitals), 218 nursing facilities and eight personal care
facilities in 36 states, as of September 30, 2000. The Company conducts
substantially all of its business through a wholly owned operating partnership,
Ventas Realty, Limited Partnership ("Ventas Realty"). The Company operates in
one segment which consists of owning and leasing health care facilities and
leasing or subleasing such facilities to third parties.
Recent Developments Regarding Vencor
On September 13, 1999, Vencor filed for protection under chapter 11 of the
Bankruptcy Code. Under the automatic stay provisions of the Bankruptcy Code, the
Company is currently prevented from exercising certain rights and remedies under
the various agreements (the "Spin Agreements") that the Company and Vencor
entered into at the time the Company spun off its health care operations to
Vencor (the "1998 Spin Off"), including the four master lease agreements
relating to 254 facilities and the single nursing facility lease that the
Company entered into with Vencor and certain of its subsidiaries (individually a
"Master Lease" and collectively the "Master Leases") and from taking certain
enforcement actions against Vencor.
The Company, Vencor and Vencor's major creditors have been engaged in
negotiations both prior and subsequent to Vencor's bankruptcy filing to
restructure Vencor's debt and lease obligations. At the time of Vencor's filing
for protection under the Bankruptcy Code, Vencor's major creditors, Vencor and
Ventas agreed upon the terms of a preliminary, non-binding agreement regarding
Vencor's plan of reorganization (the "September 1999 Agreement in Principle").
After the filing of Vencor's bankruptcy petition, Vencor and certain of its
major creditors asserted that events arising after the filing of Vencor's
bankruptcy petition have required adjustments in the Vencor financial
projections utilized as a basis for the structure of the September 1999
Agreement in Principle. Vencor and these major creditors advised the Company of
their unwillingness to proceed under the terms of the September 1999 Agreement
in Principle.
In the first quarter of 2000, the Company, Vencor and Vencor's major creditors
entered into discussions regarding proposed changes to the terms contained in
the September 1999 Agreement in Principle as well as other matters relating to
Vencor's plan of reorganization. Although the parties did not reach agreement
on the terms of an alternative restructuring of Vencor's debt and lease
obligations, Vencor, with the apparent support of its major creditors, filed its
preliminary plan of reorganization on September 29, 2000 (the "Preliminary Plan
of Reorganization"). The Preliminary Plan of Reorganization contains certain,
but not all, of the material terms for a restructuring of Vencor's debt and
lease obligations. The Company does not support the Preliminary Plan of
Reorganization. The Company has continued to engage in discussions with Vencor
and Vencor's major creditors in an effort to reach an agreement for the
restructuring of Vencor's debt and lease obligations that all parties can
support. The Company will not vote to approve any plan of reorganization that is
not acceptable to the Company, taking into consideration all facts and
circumstances at the time. The Company does not intend to update the foregoing
information until the Company, Vencor and Vencor's major creditors agree upon
the terms of Vencor's plan of reorganization. There can be no assurance that
Vencor will be successful in obtaining the approval of its creditors or the
Company for a plan of reorganization, that any such plan will not be confirmed
over the objection of the Company or any creditor, that any such plan will be on
terms acceptable to the Company, Vencor and its creditors, or that any plan of
reorganization will not have a material adverse effect on the business,
financial condition, results of operation and liquidity of the Company, on the
Company's ability to service its indebtedness and on the Company's ability to
make distributions to its stockholders as required to continue to qualify as a
REIT (a "Material Adverse Effect"). See "Note 3--Concentration of Credit Risk
and Recent Developments" to the Condensed Consolidated Financial Statements.
Vencor has stated that it intends to set December 6, 2000 as the disclosure
statement hearing date for a Vencor plan of reorganization. If the Delaware
bankruptcy court approves the disclosure statement at that time, it could be
mailed to creditors in December, 2000 and they could vote on the plan of
reorganization in January, 2001. There can be no assurance that these dates will
not change.
On November 6, 2000, Vencor filed a first amended plan of reorganization (the
"First Amended Plan") with the Bankruptcy Court incorporating into the
Preliminary Plan of Reorganization the terms relating to the proposed
comprehensive settlement of the claims by the United States against the Company
and Vencor. The First Amended Plan does not make any other changes to the terms
of the Preliminary Plan of Reorganization, which remains subject to further
amendments and supplements.
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Recent Developments Regarding Regulatory Matters
In a proposed rule refining the prospective payment system for skilled nursing
facilities ("SNF PPS") published on April 10, 2000, the Health Care Financing
Administration ("HCFA"), which is responsible for implementing the Medicare and
Medicaid provisions of the Balance Budget Refinement Act of 1999 (the
"Refinement Act"), announced proposed increases in payment rates for fiscal year
2001. In addition, the agency detailed proposed refinements to be made to the
SNF PPS case-mix classification system that would more adequately account for
high cost cases. The refinements would not alter the general structure of the
SNF PPS classification system.
In its proposed rule, HCFA developed new categories of service classifications
for payment purposes and proposed to increase reimbursement rates for higher
cost cases using a new index system based on patient clinical variables. HCFA is
accepting public comments on the proposed refinements, and a final rule will be
issued once the agency has considered all submitted comments.
The precise economic impact of the proposed rule is under review by the long-
term care industry and by the Company and Vencor.
In the interim, under the mandates of the Refinement Act, two temporary
remedies are in place. First, there is a 20% increase in the per diem
reimbursement for 15 Resource Utilization Groups ("RUGS") falling under the
Extensive Services, Special Care, Clinically Complex, High Rehabilitation and
Medium Rehabilitation categories. This 20% increase will apply only to services
furnished on or after April 1, 2000 and before the later of October 1, 2000 or
the implementation of final regulation. Second, there is a 4% increase in the
per diem reimbursement rate for all RUGS in both fiscal years 2001 and 2002.
On July 25, 2000, HCFA announced that it would delay the proposed technical
refinements to the SNF PPS until October 1, 2001, at the earliest. As a result,
the 20% interim increase has been extended from October 1, 2000 until October 1,
2001. HCFA also confirmed that the 4% increase in per diem reimbursement rate
for all RUGS would be implemented on October 1, 2000 as scheduled.
Recent Developments Regarding Income Taxes
On February 3, 2000, the Company received a refund (the "Refund") of
approximately $26.6 million from the Internal Revenue Service representing the
refund of income taxes paid by it from 1996 and 1997 and accrued interest
thereon as a result of a carryback of losses reported in the Company's 1998
federal income tax return. The United States Department of the Treasury--
Internal Revenue Service has filed a proof of claim in the Vencor bankruptcy
proceeding asserting a claim against Vencor to the Refund. Vencor, in turn, has
asserted that it is entitled to the Refund pursuant to the terms of the Tax
Allocation Agreement and on other legal grounds. Vencor and the Company are
engaged in a dispute relating to the entitlement to certain federal, state and
local tax refunds and the Internal Revenue Service may assert a right to some or
all of such refunds. See "Note 3--Concentration of Credit Risk and Recent
Developments -- Recent Developments Regarding Income Taxes" to the Condensed
Consolidated Financial Statements.
The Company, Ventas Realty, and Vencor entered into a stipulation relating to
certain of these federal, state and local tax refunds (including the Refund) on
or about May 23, 2000 (the "Tax Stipulation"). Under the terms of the Tax
Stipulation, which was approved by the Vencor bankruptcy court on May 31, 2000,
proceeds of certain federal, state and local tax refunds for tax years ending
prior to or including April 30, 1998, received by either company on or after
September 13, 1999, with interest thereon from the date of deposit at the lesser
of the actual interest earned and 3% per annum, are to be held by the recipient
of such refunds in segregated interest bearing accounts. The Tax Stipulation
contains notice provisions relating to the withdrawal of funds by either company
from the segregated accounts. The Tax Stipulation terminates automatically on
the earlier of (a) the date of termination the stipulation entered into by the
Company and Vencor (the "Rent Stipulation") for the payment of rent by Vencor to
the Company commencing in September 1999, and (b) the date Vencor provides
notice of its intent to terminate the Rent Stipulation. Both companies reserve
all rights and claims regarding the refund proceeds under the Tax Stipulation.
The Internal Revenue Service recently completed its review of the Company's
federal income tax returns for the tax years ending December 31, 1995 and
December 31, 1996. The Company will likely receive a refund of approximately
$2.4 million (the "Audit Refund") as a result of the audit adjustments to the
Company's 1995 and 1996 federal income tax returns. The Company expects that the
Audit Refund will be deposited into the segregated
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accounts maintained under the Tax Stipulation, provided that the Tax Stipulation
is in effect at the time the Audit Refund is received.
There can be no assurance as to how matters related to the tax refunds or any
tax assessed for these same years or other years of the Company will be resolved
or as to whether the Company will ultimately retain all or a portion of any of
the refund proceeds, including the Refund and the Audit Refund. Accordingly, the
refund proceeds (including the Refund) and interest earned thereon, have been
classified with the other liabilities of the Company at September 30, 2000 in
the Condensed Consolidated Financial Statements.
No net provision for income taxes has been recorded in the Condensed
Consolidated Financial Statements for the nine months ended September 30, 2000
due to the Company's current intention to continue to qualify as a REIT,
distribute 95% of its 2000 taxable income as a dividend and the existence of net
operating losses that offset the remaining liability for federal corporate
income taxes for the 2000 tax year. Although the Company intends to continue to
qualify as a REIT for the 2000 tax year and to distribute 95% of its 2000
taxable income, it is possible that economic, market, legal, tax or other
considerations may cause the Company to fail or elect not to continue to qualify
as a REIT for the 2000 tax year and distribute 95% of its 2000 taxable income.
The Company's failure to continue to qualify as a REIT could have a Material
Adverse Effect on the Company.
Recent Developments Regarding Liquidity
On January 31, 2000, the Company and all of the lenders under a prior credit
agreement entered into the Amended and Restated Credit, Security, Guaranty and
Pledge Agreement (the "Amended Credit Agreement"), which amended and restated
the $1.2 billion credit agreement (the "Bank Credit Agreement") the Company
entered into at the time of the 1998 Spin Off. See "Note 4--Bank Credit
Facility" to the Condensed Consolidated Financial Statements.
Other Recent Developments
Certain of the Company's other operators have experienced financial
difficulties that have impacted their ability to perform their obligations under
agreements with the Company. See "Note 3--Concentration of Credit Risk and
Recent Developments--Other Recent Developments" to the Condensed Consolidated
Financial Statements.
Results of Operations
The Company elected to qualify as a REIT for federal income tax purposes for
the tax year ended December 31, 1999. The Company intends to continue to
qualify as a REIT under the Internal Revenue Code of 1986, as amended, for the
tax year ended December 31, 2000 and subsequent tax years. No net provision for
income taxes has been recorded in the Condensed Consolidated Financial
Statements for the nine months ended September 30, 2000 and 1999 due to the
Company's intention to continue to qualify as a REIT which requires it to
distribute 95% of its 2000 taxable income as a dividend and the existence of net
operating losses that offset the remaining 2000 liability for federal corporate
income taxes. Although the Company intends to continue to qualify as a REIT, it
is possible that economic, market, legal, tax or other considerations may cause
the Company to fail or elect not to continue to qualify as a REIT. The
Company's failure to continue to qualify as a REIT could have a Material Adverse
Effect on the Company.
Three months ended September 30, 2000 and September 30, 1999
Rental income for the three months ended September 30, 2000 was $58.6 million,
of which $57.8 million (98.7%) resulted from leases with Vencor, as compared to
rental income for the three months ended September 30, 1999 of $57.5 million, of
which $56.6 million (98.4%) resulted from leases with Vencor. Interest income
totaled approximately $2.3 million for the three months ended September 30, 2000
as compared to approximately $1.5 million for the three months ended September
30, 1999. The increase in interest income was primarily the result of earnings
from investment of larger cash reserves during the quarter ended September 30,
2000. The Company realized a gain of approximately $0.3 million on the sale of a
tract of land pursuant to a pre-existing option during the quarter ended
September 30, 1999.
Expenses totaled $52.3 million for the quarter ended September 30, 2000, and
included $10.5 million of depreciation expense on real estate assets and $23.7
million of interest on the Amended Credit Agreement and other
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debt. For the quarter ended September 30, 1999, expenses totaled $46.3 million
and included $10.9 million of depreciation expense on real estate assets and
$22.4million of interest on the Bank Credit Agreement and other debt. The $6.0
million increase in expenses was due primarily to (a) a charge to earnings of
$12.5 million for the quarter ended September 30, 2000 for unpaid rent from
tenants versus $7.5 million reserved in the same period of the previous year,
which primarily includes the difference between the minimum monthly base rent
that would be due under the current terms of the Master Leases with Vencor and
the base rent that was paid under the terms of the Rent Stipulation, (b)
increased interest expense, and (c) increased general and administrative
expenses.
Interest expense of $23.7 million for the quarter ended September 30, 2000
increased by $1.3 million over interest expense of $22.4 million for the quarter
ended September 30, 1999. The increase in interest expense was due primarily to
the higher interest rates under the Amended Credit Agreement. The increase in
interest expense was offset in part by the reduced principal amount and reduced
amortization of deferred financing fees. For the three months ended September
30, 2000, amortization of deferred financing fees was $0.6 million compared to
$1.2 million for the three months ended September 30, 1999. See "Note 4--Bank
Credit Facility" to the Condensed Consolidated Financial Statements.
General and administrative expenses totaled $2.6 million for the quarter ended
September 30, 2000, as compared to $1.4 million for the quarter ended September
30, 1999. The increase consists primarily of state, local and other taxes and
agent fees under the Amended Credit Agreement.
Professional fees totaled approximately $2.7 million for the three months
ended September 30, 2000, as compared to $3.8 million for the three months ended
September 30, 1999. The decrease relates primarily to the reduction in unusual
professional fees ($2.4 million versus $3.2 million, respectively) incurred as a
result of ongoing negotiations with Vencor and the unusual fees incurred in the
third quarter of 1999 in connection with Vencor's bankruptcy filing and in
connection with the Company's business strategy alternatives as discussed above
in "Recent Developments Regarding Vencor" and "Recent Developments Regarding
Liquidity." Substantial legal and financial advisory expenses will continue to
be incurred by the Company until a resolution of these matters is reached,
although there can be no assurance that such a resolution will be reached.
Net income for the three months ended September 30, 2000 was $8.6 million, or
$0.13 per diluted share. Net income for the three months ended September 30,
1999 was $13.0 million, or $0.19 per diluted share.
Nine months ended September 30, 2000 and September 30, 1999
Rental income for the nine months ended September 30, 2000 was $174.3 million,
of which $171.8 million (98.6%) resulted from leases with Vencor, as compared to
rental income for the nine months ended September 30, 1999 of $171.2 million, of
which $168.5 million (98.4%) resulted from leases with Vencor. Interest income
totaled approximately $5.7 million for the nine months ended September 30, 2000
as compared to approximately $2.4 million for the nine months ended September
30, 1999. The increase in interest income was primarily the result of earnings
from investment of larger cash reserves during the nine months ended September
30, 2000. The Company realized a gain of approximately $0.3 million on the sale
of a tract of land pursuant to a pre-existing option during the nine months
ended September 30, 1999.
Expenses totaled $156.9 million for the nine months ended September 30, 2000,
and included $31.7 million of depreciation expense on real estate assets and
$71.3 million of interest on the Amended Credit Agreement and other debt. For
the nine months ended September 30, 1999, expenses totaled $120.3 million and
included $32.8 million of depreciation expense on real estate assets and $65.3
million of interest on the Bank Credit Agreement and other debt. The $36.6
million increase in expenses was due primarily to (a) a charge to earnings of
$35.8 million for unpaid rent from tenants (versus $7.5 million in the same
period in the prior year), which primarily includes the difference between the
minimum monthly base rent that would be due under the current terms of the
Master Leases with Vencor and the base rent that was paid under the terms of the
Rent Stipulation, (b) increased interest expense, (c) increased professional
fees and (d) increased general and administrative expenses.
Interest expense of $71.3 million for the nine months ended September 30, 2000
increased by $6.0 million over interest expense of $65.3 million for the nine
months ended September 30, 1999. The increase in interest expense was due
primarily to the higher interest rates under the Amended Credit Agreement. The
increase in interest expense was offset in part by the reduced principal amount
($923.4 million and $975.1 million as of September 30, 2000 and 1999,
respectively) and reduced amortization of deferred financing fees. For the nine
months ended September 30, 2000, amortization of deferred financing fees was
$2.6 million compared to $3.7 million for the nine
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months ended September 30, 1999. See "Note 4--Bank Credit Facility" to the
Condensed Consolidated Financial Statements.
General and administrative expenses totaled $7.4 million for the nine months
ended September 30, 2000, as compared to $4.8 million for the nine months ended
September 30, 1999. The increase consists primarily of state, local and other
taxes and agent fees under the Amended Credit Agreement.
Professional fees totaled approximately $9.3 million for the nine months ended
September 30, 2000, as compared to $7.6 million for the nine months ended
September 30, 1999, and included approximately $7.8 million and $6.7 million,
respectively, in unusual professional fees (legal and financial advisory)
incurred as a result of ongoing negotiations with Vencor and in connection with
the Company's business strategy alternatives as discussed above in "Recent
Developments Regarding Vencor" and "Recent Developments Regarding Liquidity."
Substantial legal and advisory expenses will continue to be incurred by the
Company until a resolution of the Vencor matter is reached, although there can
be no assurance that such a resolution will be reached.
The Company also incurred $0.4 million and $1.3 million in non-recurring
employee severance costs in the first quarter of 2000 and the first quarter of
1999, respectively.
During the first quarter of 2000, the Company incurred an extraordinary loss
of approximately $4.2 million relating to the write-off of the unamortized
deferred financing costs associated with the Bank Credit Agreement. See "Note 4-
-Bank Credit Facility" to the Condensed Consolidated Financial Statements.
After extraordinary expenses of $4.2 million, or $0.06 per diluted share, as
discussed above, net income for the nine months ended September 30, 2000 was
$18.8 million, or $.28 per diluted share. Net income for the nine months ended
September 30, 1999 was $53.5 million, or $0.79 per diluted share.
Funds from Operations
Funds from operations ("FFO") for the three months ended and the nine months
ended September 30, 2000 totaled $19.1 million and $54.7 million, or $0.28 and
$0.80 per diluted share, respectively. FFO for the comparable period in 1999
totaled $23.7 million and $86.1 million, or $0.35 and $1.27 per diluted share,
respectively. In calculating net income and FFO for the three months and nine
months ended September 30, 2000 and 1999 the Company included in its expenses
(and thus reduced net income and FFO) the aforementioned non-recurring employee
severance costs and unusual legal and financial advisory expenses. FFO for the
three months and nine months ended September 30, 2000 and 1999 is summarized in
the following table:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- ------------------------------
September 30, September 30, September 30, September 30,
-------------- -------------- ------------- --------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income......................................... $ 8,581 $13,027 $18,826 $53,531
Extraordinary loss on extinguishment of debt....... - - 4,207 -
------- ------- ------- -------
Income before extraordinary loss................ 8,581 13,027 23,033 53,531
Add: depreciation on real estate investments....... 10,522 10,944 31,682 32,832
Less: realized gain on sale of asset.............. - (254) - (254)
------- ------- ------- -------
Funds from operations........................... $19,103 $23,717 $54,715 $86,109
======= ======= ======= =======
FFO per diluted share............................. $ 0.28 $ 0.35 $ 0.80 $ 1.27
======= ======= ======= =======
</TABLE>
The Company considers FFO an appropriate measure of performance of an equity
REIT, and the Company uses the National Association of Real Estate Investment
Trust's, or NAREIT's, definition of FFO. NAREIT defines FFO as net income
(computed in accordance with accounting principles generally accepted in the
United States ("GAAP")), excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation for real estate assets, and after
adjustments for unconsolidated partnerships and joint ventures. FFO presented
herein is not necessarily comparable to FFO presented by other real estate
companies due to the fact that not all real estate companies use the same
definition. FFO should not be considered as an alternative to net income
(determined in accordance with GAAP) as an indicator of the Company's financial
performance or as an alternative to cash flow from operating activities
(determined in accordance with GAAP) as a measure of the Company's liquidity,
nor is FFO necessarily indicative of sufficient cash flow to fund all of the
Company's needs. The Company believes that in order to facilitate a clear
understanding of the consolidated historical operating results of the Company,
FFO
29
<PAGE>
should be examined in conjunction with net income as presented in the Condensed
Consolidated Financial Statements and data included elsewhere in this Form 10-Q.
Liquidity and Capital Resources
Cash provided by operations totaled $62.2 million for the nine months ended
September 30, 2000, which excludes restricted cash of $28.2 million. The $28.2
million of restricted cash represents tax refund proceeds that are governed by
the terms of the Tax Stipulation. For the nine months ended September 30, 1999
cash provided by operations totaled $80.1 million. Net cash used in financing
activities for the nine months ended September 30, 2000 totaled $105.9 million
and included a $50.9 million payment of principal on the Amended Credit
Agreement and the Bank Credit Agreement and $42.4 million payment of a cash
dividend or $0.62 per common share to stockholders of record as of September 18,
2000. Net cash provided by financing activities for the nine months ended
September 30, 1999 totaled $39.1 million after payment of a cash dividend on its
common stock of $26.5 million, or $0.39 per common share to stockholders of
record as of January 29, 1999.
The Company had cash and cash equivalents of $96.1 million (excluding
restricted cash of $28.2 million) and outstanding debt of $923.4 million at
September 30, 2000.
The Company filed its federal income tax return for the tax year ending
December 31, 1999 (the "1999 Tax Year") on September 14, 2000 electing to
qualify as a REIT for the 1999 Tax Year. On September 8, 2000, the Company
declared a cash dividend on its common stock of $42.4 million, or $0.62 per
common share. The Company paid the dividend on September 28, 2000 to
stockholders of record on September 18, 2000. This dividend, when combined with
the cash dividend of $26.5 million, or $0.39 per common share, paid by the
Company on February 17, 1999 to stockholders of record on January 29, 1999,
represents at least 95% of the Company's taxable income for the 1999 Tax Year.
This combined dividend, together with the satisfaction of certain other
criteria, enabled the Company to elect REIT status for the 1999 Tax Year.
The Company did not declare or pay a dividend in the first, second or third
quarters of the tax year ending December 31, 2000 (the"2000 Tax Year"). The
Company intends to continue to qualify as a REIT for the 2000 Tax Year and
subsequent tax years. Such qualification requires the Company to declare a
distribution of 95% of its taxable income for any given tax year not later than
September 15 of the year following the end of the tax year in respect of which
the dividend is to be paid (i.e. September 15, 2001 for the 2000 Tax Year) and
pay such dividend not later than December 31 of that same year (i.e. December
31, 2001 for the 2000 Tax Year), or, if earlier, prior to the payment of the
first regular dividend for the then current year. While such distributions are
not required to be made quarterly, if they are not made by January 31 of the
year following the end of the tax year in respect of which the dividend is to be
paid (i.e. January 31, 2001 for the 2000 Tax Year), the Company is required to
pay a 4% non-deductible excise tax on the difference between 85% of its taxable
net income for the year in respect of which the dividend is to be paid and the
aggregate amount of dividends paid for that tax year on or prior to January 31
of the year following the year in respect of which the dividend is to be paid.
The Company currently intends to distribute 95% of its taxable income for the
2000 Tax Year, but there can be no assurance that it will do so or when such
distribution will be made. The Company's dividend for the 2000 Tax Year may be
satisfied by a distribution of a combination of cash and other property or
securities.
The amount of the total dividend declared and paid by the Company for the 1999
Tax Year should not be viewed as an indication of future dividend levels, which
are likely to be lower. The Company is unable to predict the amount or timing
of future dividends due to the uncertainty over the restructuring of Vencor.
It is important to note for purposes of the required REIT distributions that
the Company's taxable income may vary significantly from historical results and
from current income determined in accordance with accounting principles
generally accepted in the United States depending on the resolution of a variety
of factors. Under certain circumstances, the Company may be required to make
distributions in excess of FFO (as defined by the National Association of Real
Estate Investment Trusts) in order to meet such distribution requirements. In
the event that timing differences or cash needs occur, the Company may find it
necessary to borrow funds or to issue equity securities (there being no
assurance that it will be able to do so) or, if possible, to pay taxable stock
dividends, distribute other property or securities or engage in a transaction
intended to enable it to meet the REIT distribution requirements. The Company's
ability to engage in certain of these transactions is restricted by the terms of
the Amended Credit Agreement. Any such transaction would likely require the
consent of the "Required Lenders"
30
<PAGE>
under the Amended Credit Agreement, and there can be no assurance that such
consent would be obtained. In addition, the failure of Vencor to make rental
payments under the Master Leases would impair materially the ability of the
Company to make distributions. Consequently, there can be no assurance that the
Company will be able to make distributions at the required distribution rate or
any other rate.
Although the Company intends to continue to qualify as a REIT for the 2000 Tax
Years and subsequent tax years, it is possible that economic, market, legal, tax
or other considerations may cause the Company to fail or elect not to continue
to qualify as a REIT in any such tax year. If the Company were to fail or elect
not to continue to qualify as a REIT in any such tax year, the Company would be
subject to 35% federal income tax and to the applicable state and local income
taxes for the affected years. Such tax obligations would have a Material Adverse
Effect on the Company. Unless eligible for limited relief, if the Company
failed, or revoked its election to qualify as a REIT the Company would not be
eligible to elect again to be treated as a REIT before the fifth taxable year
after the year of such termination or revocation.
The Company is required to make a $50.0 million payment on the $200 million
Tranche A Loan under the Amended Credit Agreement within 30 days after the
Vencor Effective Date. The Company currently believes that this $50.0 million
payment will be funded by cash on hand and cash flows from operations.
Under the terms of the Preliminary Plan of Reorganization the Company would
be in compliance with the financial covenants contained in the Amended Credit
Agreement if the Vencor Effective Date occurs on or before December 31, 2000.
Under the terms of the Amended Credit Agreement, an event of default is deemed
to have occurred if the Vencor Effective Date does not occur on or before
December 31, 2000. Subject to any defenses available to the Company, if such an
event of default were to occur, the Company could be required to immediately
repay all the indebtedness under the Amended Credit Agreement upon the demand of
the "Required Lenders," as defined in the Amended Credit Agreement. The Company
has initiated discussions with the administrative agent for its lenders under
the Amended Credit Agreement to obtain a waiver or amendment of this covenant.
Under the Amended Credit Agreement, a waiver or amendment of this covenant must
be approved by lenders holding (in the aggregate) greater than 50% of the total
credit exposure under the Amended Credit Agreement. The Company believes that
the holders of a majority of the Vencor bank indebtedness also hold a
substantial portion of the total credit exposure under the Amended Credit
Agreement. There can be no assurance (i) that a plan of reorganization for
Vencor will become effective on or before December 31, 2000, (ii) that the
Company will obtain a waiver or amendment of the covenant if a plan of
reorganization for Vencor is not effective on or before December 31, 2000, (iii)
that the terms of such a waiver or amendment would not have a Material Adverse
Effect on the Company, or (iv) that the failure to obtain such a waiver or
amendment would not have a Material Adverse Effect on the Company.
Capital expenditures to maintain and improve the leased properties generally
will be incurred by the tenants under the leases with the Company. Accordingly,
the Company does not believe that it will incur any major expenditures in
connection with the leased properties. After the terms of the leases expire, or
in the event that the tenants are unable to meet their obligations under the
leases, the Company anticipates that any expenditures for which it may become
responsible to maintain the leased properties will be funded by cash flows from
operations and, in the case of major expenditures, through additional borrowings
or issuance of equity. To the extent that unanticipated expenditures or
significant borrowings are required, the Company's liquidity may be affected
adversely.
The Company does not currently intend to acquire any additional properties. In
addition, the Company's access to debt and equity capital is limited under the
terms of the Amended Credit Agreement and current market conditions.
31
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion of the Company's exposure to various market risks
contains "forward looking statements" that involve risks and uncertainties.
These projected results have been prepared utilizing certain assumptions
considered reasonable in light of information currently available to the
Company. Nevertheless, because of the inherent unpredictability of interest
rates as well as other factors, actual results could differ materially from
those projected in such forward looking information.
The Company earns revenue by leasing its assets under leases that primarily
are long-term triple net leases in which the rental rate is generally fixed with
annual escalators, subject to certain limitations. The Company's debt
obligations are floating rate obligations whose interest rate and related
monthly interest payments vary with the movement in LIBOR. See "Note 4--Bank
Credit Facility" to the Condensed Consolidated Financial Statements. The general
fixed nature of the Company's assets and the variable nature of the Company's
debt obligations creates interest rate risk. If interest rates were to rise
significantly, the Company's lease revenue might not be sufficient to meet its
debt obligations. In order to mitigate this risk, at or about the date the
Company spun off its health care operations in connection with the 1998 Spin
Off, it also entered into an interest rate swap to effectively convert most of
its floating rate debt obligations to fixed rate debt obligations. Interest rate
swaps generally involve the exchange of fixed and floating rate interest
payments on an underlying notional amount. As of September 30, 2000, the Company
had an $875 million notional amount interest rate swap outstanding with a highly
rated counterparty in which the Company pays a fixed rate of 5.985% and receives
LIBOR from the counterparty. The notional amount of the interest rate swap
agreement is scheduled to decline as follows:
<TABLE>
<CAPTION>
Notional Amount Date
--------------- ------------------
<S> <C>
850,000,000 December 31, 2000
800,000,000 December 31, 2001
775,000,000 December 31, 2002
-- September 30, 2003
</TABLE>
When interest rates rise the interest rate swap agreement increases in fair
value to the Company and when interest rates fall the interest rate swap
agreement declines in value to the Company. As of September 30, 2000, interest
rates had risen and the interest rate swap agreement was in an unrealized gain
position to the Company of approximately $12.0 million. Generally, interest rate
swap agreements with longer terms evidence greater dollar values of variation
when interest rates change. To highlight the sensitivity of the interest rate
swap agreement to changes in interest rates, the following summary shows the
effects of a hypothetical instantaneous change of 100 basis points (BPS) in
interest rates as of September 30, 2000:
<TABLE>
<CAPTION>
<S> <C>
Notional Amount.................................... $875,000,000
Fair Value to the Company.......................... $ 11,979,619
Fair Value to the Company Reflecting
Change in Interest Rates
-100 BPS...................................... ($6,202,343)
+100 BPS...................................... $29,580,496
</TABLE>
The terms of this interest rate swap agreement require that the Company make a
cash payment or otherwise post collateral to the counterparty if the fair value
loss to the Company exceed certain levels (the "threshold levels"). The
threshold levels vary based on the relationship between the Company's debt
obligations and the tangible fair value of its assets as defined in the Bank
Credit Agreement. As of September 30, 2000, the threshold level under the
interest rate swap agreement was a fair value unrealized loss of $35.0 million
and the interest rate swap agreement was in an unrealized gain position to the
Company of $12.0 million; therefore, no collateral was required to be posted.
Under the interest rate swap agreement, if collateral must be posted, the
principal amount of such collateral must equal the difference between the fair
value unrealized loss of the interest rate swap agreement at the time of such
determination and the threshold amount. On January 31, 2000, the Company entered
into a letter agreement with the counterparty to the swap agreement for the
purpose of amending the swap agreement. The letter agreement provides that, for
purposes of certain calculations set forth in the swap agreement, the parties
agree to continue to use certain defined terms set forth in the Bank Credit
Agreement. See "Note 4--Bank Credit Facility" to the Condensed Consolidated
Financial Statements.
32
<PAGE>
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Except as set forth in "Note 5--Litigation" to the Condensed Consolidated
Financial Statements (which is incorporated by reference into this Item 1),
there has been no material change in the status of the litigation reported in
the Company's Annual Report on Form 10-K for the year ended December 31, 1999
and the Company's Quarterly Reports on Form 10-Q for the quarters ending March
31, 2000 and June 30, 2000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company had a $275.0 million Bridge Loan as part of its Bank Credit
Agreement, which was originally scheduled to mature on October 30, 1999. On
October 29, 1999, the Company entered into a Waiver and Extension Agreement with
over 95 percent of the lenders under the Bank Credit Agreement providing for a
four month extension of the Bridge Loan. Two lenders that did not execute the
Waiver and Extension Agreement but that did execute the Amended Credit Agreement
have asserted a right to seek current repayment of their portion of the $1.2
billion under the Bank Credit Agreement. On January 31, 2000, the Company and
all of its lenders entered into the Amended Credit Agreement, which amended and
restated the $1.2 billion Bank Credit Agreement, including the Bridge Loan. See
"Note 3--Concentration of Credit Risk and Recent Developments," "Note 4--Bank
Credit Facility," and "Note 5--Litigation" to the Condensed Consolidated
Financial Statements.
ITEM 5. OTHER INFORMATION
R. Gene Smith resigned as a member of the Board of Directors of the Company
effective October 31, 2000. Mr. Smith resigned to devote his full time and
attention to the management of his many other businesses.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
4.1 Letter Agreement relating to a waiver of the provisions of Article
XII of the Certificate of Incorporation of Ventas, Inc. in favor of
The Baupost Group, LLC, dated October 27, 1999.
4.2 Letter Agreement relating to a waiver of the provisions of Article
XII of the Certificate of Incorporation of Ventas, Inc. in favor of
Cohen & Steers Capital Management, Inc., dated May 8, 2000.
4.3 Letter Agreement terminating the waiver of the provisions of Article
XII of the Certificate of Incorporation of Ventas, Inc. in favor of
Franklin Mutual Advisors, LLC, dated September 27, 2000.
27 Financial Data Schedule.
(b) REPORTS ON FORM 8-K:
On September 12, 2000, the Company filed a Current Report on Form 8-K
announcing that on September 8, 2000 its board of directors voted to pay a cash
dividend of $0.62 per share payable on September 28, 2000 to stockholders of
record on September 18, 2000 and that the Company would not declare or pay a
third quarter 2000 dividend at that time.
On October 2, 2000, the Company filed a Current Report on Form 8-K announcing,
among other things, that it did not support the preliminary plan of
reorganization filed by Vencor, Inc. on September 29, 2000 and that the plan
would require changes on substantive issues before the Company would support it.
The Company also announced that it would be in compliance with the covenants
under its bank credit agreement if the preliminary plan of reorganization filed
on September 29, 2000 by Vencor were to become effective by December 31, 2000
and that it intends to engage in discussions with its lenders to obtain a waiver
or amendment of this covenant if it appears that an acceptable plan will not
become effective by December 31, 2000.
33
<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.
Date: November 7, 2000
Ventas, Inc.
By: /s/ Debra A. Cafaro
-------------------
Debra A. Cafaro
Chief Executive Officer and President
By: /s/ Mary L. Smith
-----------------
Mary L. Smith
Principal Accounting Officer
34
