<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1999
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
-------- ---------
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Commission file number 33-31717-A
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QUORUM HEALTH GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 62-1406040
(State of incorporation) (IRS Employer Identification No.)
103 CONTINENTAL PLACE, BRENTWOOD, TENNESSEE 37027
(Address of principal executive offices) (Zip Code)
(615) 371-7979
(Registrant's telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at November 8, 1999
- ----- -------------------------------
Common Stock, $.01 Par Value 70,657,723 Shares
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months
Ended September 30
------------------------
1999 1998
--------- ---------
<S> <C> <C>
Revenue:
Net patient service revenue $ 396,645 $ 352,459
Hospital management/professional services 19,553 20,792
Reimbursable expenses 15,087 16,110
--------- ---------
Net operating revenue 431,285 389,361
Salaries and benefits 178,239 157,846
Reimbursable expenses 15,087 16,110
Supplies 62,072 51,319
Fees 38,471 35,171
Other operating expenses 29,750 26,423
Provision for doubtful accounts 39,610 27,796
Equity in earnings of affiliates (2,124) (5,325)
Leases and rentals 9,057 7,129
Depreciation and amortization 26,199 21,325
Interest 16,730 9,133
Investigation and litigation related costs 1,098 --
Minority interest (349) 574
--------- ---------
Income before income taxes 17,445 41,860
Provision for income taxes 6,821 16,367
--------- ---------
Net income $ 10,624 $ 25,493
========= =========
Earnings per share:
Basic $ 0.15 $ 0.34
========= =========
Diluted $ 0.14 $ 0.33
========= =========
Weighted average shares outstanding:
Basic 73,218 75,593
========= =========
Diluted 77,868 77,319
========= =========
</TABLE>
See accompanying notes.
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QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
September 30 June 30
1999 1999
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 16,562 $ 22,258
Accounts receivable, less allowance for
doubtful accounts of $87,230 at
September 30, 1999 and $83,896 at
June 30, 1999 330,974 332,312
Supplies 39,344 39,003
Other 55,127 46,838
---------- ----------
Total current assets 442,007 440,411
Property, plant and equipment, at cost:
Land 89,635 88,157
Buildings and improvements 438,313 435,525
Equipment 597,676 584,017
Construction in progress 27,855 24,875
---------- ----------
1,153,479 1,132,574
Less accumulated depreciation 320,317 297,454
---------- ----------
833,162 835,120
Cost in excess of net assets acquired, net 225,693 226,038
Investments in unconsolidated entities 248,208 259,709
Other 71,894 70,670
---------- ----------
Total assets $1,820,964 $1,831,948
========== ==========
</TABLE>
3
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<TABLE>
<CAPTION>
September 30 June 30
1999 1999
---------- ----------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 95,988 $ 96,904
Accrued salaries and benefits 75,342 72,558
Other current liabilities 39,462 34,841
Current maturities of long-term debt 965 913
---------- ----------
Total current liabilities 211,757 205,216
Long-term debt, less current maturities 843,669 872,213
Deferred income taxes 33,422 33,422
Professional liability risks and other
liabilities and deferrals 37,723 36,456
Minority interests in consolidated entities 58,984 59,975
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value;
300,000 shares authorized; 73,227
issued and outstanding at September 30,
1999 and 73,166 at June 30, 1999 732 732
Additional paid-in capital 253,832 253,714
Retained earnings 380,845 370,220
---------- ----------
635,409 624,666
---------- ----------
Total liabilities and stockholders'
equity $1,820,964 $1,831,948
========== ==========
</TABLE>
See accompanying notes.
4
<PAGE> 5
QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Three Months
Ended September 30
------------------------
1999 1998
--------- ---------
<S> <C> <C>
Net cash provided by operating activities $ 48,661 $ 31,027
Investing activities:
Purchase of acquired companies, net of
working capital settlements -- (44,120)
Purchase of property, plant and equipment (22,026) (31,009)
Other (277) (331)
--------- ---------
Net cash used in investing activities (22,303) (75,460)
Financing activities:
Borrowings under bank debt 66,300 149,100
Repayments of bank debt (244,600) (106,700)
Borrowing under convertible subordinated
debentures 150,000 --
Change in outstanding checks and overnight
investment (2,517) (4,870)
Other (1,237) 958
--------- ---------
Net cash (used in) provided by financing activities (32,054) 38,488
--------- ---------
Decrease in cash (5,696) (5,945)
Cash at beginning of period 22,258 17,549
--------- ---------
Cash at end of period $ 16,562 $ 11,604
========= =========
Supplemental cash flow information:
Interest paid $ (13,340) $ (8,212)
========= =========
Income taxes paid $ (2,830) $ (143)
========= =========
</TABLE>
See accompanying notes.
5
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QUORUM HEALTH GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Quorum
Health Group, Inc. and subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three months ended September 30, 1999 are
not necessarily indicative of the results that may be expected for the year
ending June 30, 2000. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended June 30, 1999. Certain prior year amounts
have been reclassified to conform to the current year presentation.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This standard will require the Company to
recognize all derivatives on the balance sheet at their fair value. Derivatives
that are not hedges must be adjusted to fair value through changes to the
Company's income statement. For interest rate swap agreements that qualify as
hedges, the Company will offset changes in fair value against the change in fair
value of the hedged assets, liabilities, or firm commitments through changes to
the Company's earnings. The Company will adopt this new FASB standard on July 1,
2000. The Company is presently evaluating the new standard to determine its
effect on the earnings and financial position of the Company.
On March 31, 1999, the FASB released a proposed interpretation of APB Opinion
No. 25 "Accounting for Certain Transactions involving Stock Compensation" which
requires variable-award accounting for repriced stock options. This proposed
interpretation would be effective upon issuance. The expected issuance date has
been delayed to the first calendar quarter of 2000. The interpretation would
generally cover events that occur after December 15, 1998. No adjustments would
be made to financial statements for periods prior to the effective date and no
expense would be recognized for any additional compensation costs attributable
to periods before the effective date.
3. ACQUISITIONS, JOINT VENTURES AND SALES
During fiscal 1999, the Company acquired four hospitals and affiliated health
care entities. In connection with the acquisitions, the Company entered into
operating lease agreements to lease certain land and buildings with an
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estimated fair value of $108.7 million. Effective April 8, 1999, the Company
sold Park Medical Center in Columbus, Ohio.
A majority-owned subsidiary of the Company and a subsidiary of Columbia/HCA
Healthcare Corp. (Col/HCA) formed a joint venture in Vicksburg, Mississippi.
Col/HCA contributed Vicksburg Medical Center. The Company's subsidiary and its
existing physician shareholders contributed Parkview Regional Medical Center and
affiliated businesses. The Company, through its subsidiary, has a majority
equity interest in the joint venture and is the manager.
The operating results of the acquisitions, joint ventures and sales have been
consolidated in the accompanying condensed consolidated statements of income for
the periods subsequent to acquisition and for the periods prior to the sale.
The following unaudited pro forma results of operations give effect to the
operations of the joint venture and the entities acquired and sold in fiscal
1999 as if the respective transactions had occurred at the beginning of the
period presented (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months
Ended
September 30
----------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net operating revenue $ 431,244 $ 430,186
Net income 11,137 24,778
Earnings per share:
Basic 0.15 0.33
Diluted 0.15 0.32
</TABLE>
The pro forma results of operations do not purport to represent what the
Company's results of operations would have been had such transactions in fact
occurred at the beginning of the periods presented or to project the Company's
results of operations in any future period.
4. LONG-TERM DEBT
On August 31, 1999, the Company issued $150.0 million of convertible
subordinated debentures due 2009 to Welsh, Carson, Anderson & Stowe, VIII, LP
and certain WCAS VIII affiliates, including Russell L. Carson, Chairman of the
Company's Board of Directors. The debentures were sold for cash at their face
value. The debentures bear interest at 6.0% per annum. Interest is payable
quarterly. The debentures are convertible into common shares at a conversion
price of $11.25 per share. The debentures will automatically convert at any time
after three years if the average of the closing price of the Company's stock
over any 90 day period is more than 150% of the conversion price. The debentures
are callable at the Company's option at any time after August 31, 2001. In the
event of a merger, consolidation or sale of more than 50% of the Company's
assets, the holder of the debentures has the option to have the debentures
prepaid in full. The debentures have
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antidilution protection, including, under certain circumstances, issuance of
common stock below the then applicable conversion price. The shares into which
the debentures are convertible have certain voting restrictions and must be held
for a two-year period beginning August 1999. The debentures are subordinated in
right of payment to all debt. The proceeds were used to reduce the Company's
outstanding debt under its revolving credit facility.
5. INVESTIGATION AND LITIGATION RELATED COSTS
During the three months ended September 30, 1999, the Company incurred $1.1
million in investigation and litigation related costs related primarily to the
qui tam and shareholder actions against the Company (See Note 9).
6. INCOME TAXES
The provision for income taxes for the three months ended September 30, 1999 and
1998 is different from that which would be obtained by applying the statutory
federal income tax rate to income before income taxes due to permanent
differences and the provision for state income taxes.
7. EARNINGS PER SHARE
Basic earnings per share is based on the weighted average number of common
shares outstanding. Diluted earnings per share is based on the weighted average
number of common shares outstanding, and the effect of dilutive securities which
are convertible subordinated debentures and stock options. Outstanding options
to purchase 4.2 million and 2.0 million shares of common stock were not included
in the computation of earnings per share for the three months ended September
30, 1999 and 1998, respectively, because the options' exercise prices were
greater than the average market price of the common stock (See Note 8).
The following table sets forth the computation of basic and diluted earnings per
share (in thousands, except per share amounts):
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<TABLE>
<CAPTION>
THREE MONTHS
ENDED
SEPTEMBER 30
---------------------
1999 1998
------- -------
<S> <C> <C>
Numerator:
Net income $10,624 $25,493
Interest expense on convertible
debentures, net of taxes 457 --
------- -------
Numerator for dilutive earnings
per share $11,081 $25,493
======= =======
Denominator:
Shares used for basic earnings
per share 73,218 75,593
Effect of dilutive securities:
Convertible subordinated debentures 4,444 --
Stock options 206 1,726
------- -------
Shares used for dilutive earnings
per share 77,868 77,319
======= =======
Basic earnings per share $ 0.15 $ 0.34
======= =======
Diluted earnings per share $ 0.14 $ 0.33
======= =======
</TABLE>
8. STOCKHOLDERS' EQUITY AND STOCK BENEFIT PLANS
In March 1999, the Company's Board of Directors approved a plan to allow all
employees to exchange "underwater" stock options. Based on the exchange, the
Company canceled 5.2 million options at exercise prices ranging from $12.09 to
$33.06 and issued 3.6 million options at an exercise price of $9.00. The effect
was to reduce the number of options held to offset the benefit of a lower
exercise price. The estimated economic value of the grants was generally
unchanged as a result of the exchange. Under the proposed interpretation of APB
Opinion No. 25, repriced options would have variable-award accounting (See Note
2). Should the Company be required to apply variable-award accounting to the
repriced options, such options will vest and terminate thirty days after the
Company gives notice to the employees. Variable-award accounting will be
eliminated after the option termination date. As of September 30, 1999, there
were 5.9 million options outstanding with a weighted average exercise price of
$9.66.
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9. CONTINGENCIES
Management continually evaluates contingencies based on the best available
evidence and believes that provision for losses has been provided to the extent
necessary.
Net Patient Service Revenue
Final determination of amounts earned under the Medicare and Medicaid programs
often occurs in subsequent years because of audits by the programs, rights of
appeal and the application of numerous technical provisions. In the opinion of
management, adequate provision has been made for adjustments that may result
from such routine audits and appeals.
Income Taxes
The Internal Revenue Service (IRS) is in the process of conducting examinations
of the Company's federal income tax returns for the fiscal years ended June 30,
1993 through 1998. The IRS has proposed certain adjustments in connection with
its examination of the Company's federal income tax returns for the fiscal years
ending June 30, 1993 through 1995. The most significant adjustments involve the
tax accounting methods adopted for computing bad debt expense and the valuation
of purchased hospital property, plant and equipment and related depreciable
lives. The Company has protested substantially all of the proposed adjustments
through the appeals process of the IRS. In the opinion of management, the
ultimate outcome of the IRS examinations will not have a material effect on the
Company's results of operations or financial position.
Impact of Year 2000
As with most other industries, hospitals and affiliated health care entities use
information systems that may misidentify dates beginning January 1, 2000 or
earlier, resulting in system or equipment failures or miscalculations.
Information systems include computer programs, building infrastructure
components and computer-aided biomedical equipment. The Company has a Year 2000
strategy for its owned hospitals that includes phases for education, inventory
and assessment of applications and equipment at risk,
conversion/remediation/replacement, validation and post-implementation. The
Company can provide no assurances that applications and equipment the Company
believes to be Year 2000 compliant will not experience difficulties, that Year
2000 issues will not arise that the Company did not contemplate or erroneously
assigned a low level of risk, or that the Company will not experience
difficulties obtaining resources needed to make modifications to or replace the
Company's affected systems and equipment. Failure by the Company or third
parties on which it relies to resolve Year 2000 issues could have a material
adverse effect on the Company's results of operations and its ability to provide
health care services.
The Company's position is that it is not responsible for ensuring Year 2000
compliance by its managed hospitals, but the Company cannot provide assurance
that its managed hospitals will not seek to hold it responsible, or that it
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will not ultimately be found liable, for any losses they incur arising out of
the Year 2000 problem.
The Company can give no assurances that issues related to Year 2000 will not
have a material adverse effect on the Company's financial condition or results
of operations.
Litigation
The Company is currently, and from time to time expects to be, subject to
claims, suits and investigations arising in the ordinary course of business. The
Company may not know about investigations or qui tam actions filed against the
Company by private parties on behalf of the federal or state governments.
Plaintiffs in these matters may request punitive or other damages that may not
be covered by insurance. Except for the litigation described below, the Company
is not currently a party to any such proceeding which, in management's opinion,
if adversely decided, would have a material effect on the Company's results of
operations or financial position.
False Claims Act Litigation
In June 1993, the Office of the Inspector General of the Department of Health
and Human Services requested information from the Company in connection with an
investigation involving the Company's procedures for preparing Medicare cost
reports. In January 1995, the United States Department of Justice issued a Civil
Investigative Demand which also requested information from the Company in
connection with the same investigation. As a part of the government's
investigation, several former and current employees were interviewed. The
Company cooperated fully with the investigation. The Company received no
communication from the government on this matter from approximately June 1996
until August 1998.
In August 1998, the government informed the Company that the investigation was
prompted by a lawsuit filed under the False Claims Act. The suit was filed in
January 1993 by a former employee of a hospital managed by a Company subsidiary.
These lawsuits, commonly known as qui tam actions, are filed "under seal." That
means that the claims are kept secret until the government decides whether to
join the case. The person who files the lawsuit is called a "relator". At a
meeting in September 1998, the Company learned from the government that it would
likely join in the case. The government joined the case against the Company in
October 1998. The former employee's lawsuit named the Company and its
subsidiary, Quorum Health Resources, Columbia/HCA Healthcare Corporation and all
hospitals that the Company or Columbia/HCA owned, operated or managed from 1984
through 1997, as defendants. The unsealed complaint, prepared by the relator,
alleged that the Company knowingly prepared and caused to be filed cost reports
which claimed payments from Medicare and other government payment programs
greater than the amounts due.
In January 1999, the Company filed motions with the court asking to be separated
from the case against co-defendant Columbia/HCA. The government did not oppose
the motion to separate the cases against the Company and Columbia/HCA. On
February 2, 1999, the government filed an amended complaint.
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On that date, the government also filed a notice of non-intervention advising
the Court that it would not proceed on some of the relator's allegations, and
that it would not sue individual managed hospital clients. The government's
complaint did not name as defendants any hospital the Company managed. It does
name the Company, Quorum Health Resources and each subsidiary which now owns or
has ever owned a hospital. Subsequently, the court granted the Company's motion
to be separated, dismissed the Company from the case, and directed plaintiffs to
file a new action against the Company alone. Plaintiffs did so on February 24,
1999.
The February 24, 1999 complaint alleges that the Company, on behalf of hospitals
it managed between 1985 and 1995 and hospitals it owned from 1990 to the
present, violated the False Claims Act by filing false Medicare cost reports.
The government asserts that the false claims in the cost reports are reflected
in "reserve analyses" created by the Company. The complaint also alleges that
these cost report filings were prepared as the result of Company policy.
In March 1999, as the Company had requested, the court appointed a mediator to
facilitate settlement discussions between the Company and the government.
Meetings with the mediator were held on June 11, 1999 and November 4, 1999.
In April 1999, the Company filed several motions to dismiss the government's
complaint in whole or in part as well as a motion to dismiss the relator from
the case. The government and the relator replied to the Company's motions in
June, 1999 and the Company filed a reply in July, 1999. The court has not ruled
on the Company's motions.
This qui tam action seeks three times the amount of damages caused to the United
States by the Company's submission of any alleged false claims to the
government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and attorneys' fees and costs.
Other Qui Tam Actions and Related Investigations
In May 1998, the Company was informed that it was a defendant in another qui tam
action involving home health services provided by two of the Company's owned
hospitals and alleging that the Company had violated Medicare laws. This action
was filed under seal in June 1996 by a former employee, whom the Company fired
in April 1996. The United States Attorney's Office allowed the Company an
opportunity to review the results of the government's investigations and discuss
the allegations made in the action prior to the government making a decision to
intervene as a plaintiff. The lawsuit remains under seal for all other purposes.
The Company has cooperated fully with the United States Attorney's Office and
provided additional information and made employees available for interviews. The
Company is now engaged in preliminary settlement discussions with the
government.
As part of its ongoing discussions, the Company has learned from the same U.S.
Attorney that there are two additional unrelated qui tam complaints against the
Company alleging Medicare violations at one owned and two managed hospitals.
Both matters remain under seal. The Company has not seen the complaint in either
matter. The government has stated that it intends to
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investigate these allegations. The Company intends to cooperate with the
government's investigation.
The Class and Derivative Actions
In October and November 1998, some of the Company's stockholders filed
lawsuits against the Company in the U.S. District Court for the Middle
District of Tennessee. In January 1999, the court consolidated these cases
into a single lawsuit. (M.D. Tenn. No. 3-98-1004) The plaintiffs filed an
amended complaint in March 1999. The plaintiffs seek to represent a class of
plaintiffs who purchased the Company's common stock from October 25, 1995
through October 21, 1998, except for insiders of the Company and their
immediate families. The consolidated complaint names the Company, several of
its officers and one of its outside directors, as defendants.
The complaint alleges that defendants violated the Securities Exchange Act of
1934. The plaintiffs claim that the Company materially inflated its net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in the Company's Form 10-K filed
in September 1996, was false: "The Company believes that its owned hospitals are
in substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, the Company filed a motion
to dismiss the complaint. The plaintiffs have filed papers opposing the motion,
and the judge has not yet ruled on the motion. The Company intends to vigorously
defend the claims and allegations in this action.
On November 2, 1998, a lawsuit was filed against the Company, all of its current
directors and two former directors in the U.S. District Court for the Northern
District of Alabama. On January 14, 1999, this suit was transferred by agreement
of the parties to the U.S. District Court for the Middle District of Tennessee.
(M.D. Tenn. No. 3-99-0055) On February 16, 1999, the defendants filed a motion
to dismiss the original complaint. The court then granted the plaintiff
permission to file a first amended complaint, which, when filed, mooted the
original motion to dismiss. On April 30, 1999, the defendants moved to dismiss
the first amended complaint. The court on July 1, 1999, granted plaintiff's
motion for leave to file a second amended complaint and denied as moot the
motion to dismiss the first amended complaint. The second amended complaint
asserts four claims: a shareholders' derivative claim for breach of fiduciary
duty, a shareholders' derivative claim for violations of the Racketeer
Influenced and Corrupt Organizations Act, a shareholders' derivative claim for
injunctive relief, and a purported class action claim for breach of fiduciary
duty. As the basis for each of these claims, plaintiff alleges that the
defendants in 1993 were aware that the Company was filing allegedly false cost
reports and that the defendants "mandated" that the illegal acts continue in
violation of applicable Medicare and Medicaid laws. The defendants have filed a
motion to dismiss the second amended complaint. The plaintiff has responded to
this motion, but the court has not yet ruled on this motion. All of the
defendants plan to vigorously defend this litigation.
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The Company cannot at this time predict the effect or outcome of any of the
ongoing investigations or the qui tam, class or stockholders' derivative
actions, or whether any additional investigations or litigation will be
commenced. If the Company is found to have violated federal or state laws
relating to Medicare, Medicaid or other government programs, then it may be
required to pay substantial fines and civil and criminal penalties and also may
be excluded from participating in the Medicare and Medicaid programs and other
government programs. Similarly, the amount of damages sought in the qui tam
actions are substantial. The Company could be subject to substantial costs
resulting from an adverse outcome of any of these actions. In an effort to
promptly resolve one or more of these matters, the Company may choose to
negotiate a settlement. Amounts the Company pays to settle any of these matters
may be material. Any one or more of these actions or costs could have a material
adverse effect on the Company's results of operations or financial position.
10. SEGMENT INFORMATION
The Company's segments consist of (i) healthcare systems owned and operated by
the Company and (ii) management of hospitals and healthcare systems for other
owners. The Company evaluates performance based on operating earnings of the
respective business units.
The Company's net revenues, EBITDA and assets are summarized in the following
table (EBITDA is defined as earnings before interest, minority interest,
investigation and litigation related costs, income taxes, depreciation and
amortization expense):
<TABLE>
<CAPTION>
Three Months Ended
September 30,
---------------------------
1999 1998
---------- ----------
<S> <C> <C>
Net revenues:
Owned hospitals $ 396,645 $ 352,459
Management services 34,640 36,902
---------- ----------
$ 431,285 $ 389,361
========== ==========
EBITDA:
Owned hospitals $ 53,600 $ 64,128
Management services 7,523 8,764
---------- ----------
$ 61,123 $ 72,892
========== ==========
Assets:
Owned hospitals $1,778,451 $1,538,700
Management services 42,513 43,503
---------- ----------
$1,820,964 $1,582,203
========== ==========
</TABLE>
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11. SUBSEQUENT EVENT
From October 1 through November 3, 1999, the Company repurchased 2.6 million
shares of common stock for an aggregate purchase price of $17.3 million. All of
these shares were purchased in open market transactions. There are approximately
1.8 million shares remaining for repurchase under the existing five-million
share stock repurchase program authorized in October 1998.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
You should read the following along with the Condensed Consolidated
Financial Statements and accompanying notes.
FORWARD-LOOKING INFORMATION
This discussion includes "forward-looking statements." Forward-looking
statements include all statements that do not relate solely to historical or
current facts, and can be identified by the use of some words, including "may,"
"believe," "will," "expect," "project," "estimate," "anticipate," "plan" or
"continue." We have based these forward-looking statements on our current plans
and expectations and projections about future events. However, risks,
uncertainties and assumptions that would cause or contribute to material
differences in our future financial condition and results of operations include:
- possible changes in Medicare and Medicaid that may further
limit payments to our owned hospitals;
- the efforts of insurers, managed care companies, patients and
other payors to reduce their payments to our owned hospitals;
- potential adverse impact of known and unknown government
investigations and litigation;
- the possible enactment of federal, state or local health care
reforms;
- changes in federal, state or local regulations affecting the
health care industry;
- difficulties in containing costs in proportion to payments
from our payors;
- difficulties in billing and collecting accounts receivable and
the related impact upon cash flow and bad debt expense;
- difficulties in finding attractive acquisitions and
integrating acquired hospitals into our operations;
- market and geographic concentration of operations;
- the highly competitive nature of the health care business;
- potential loss of physicians or other key personnel;
- claims and legal actions relating to professional liability;
- the ability to address internal and external Year 2000 issues,
including disruptions from system conversions;
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<PAGE> 17
- our substantial indebtedness and difficulty raising capital in
the future;
- fluctuations in the market value of our common stock;
- changes in accounting pronouncements; and
- changes in general economic conditions.
OVERVIEW
We are a leading provider of health care services through our owned
acute care hospitals and regional health care systems located throughout the
United States. We are also the largest provider of management services to acute
care hospitals in the United States, primarily through our subsidiary, Quorum
Health Resources, LLC.
For the three months ended September 30, 1999 and 1998, our owned
hospitals accounted for 92% and 91% of our net operating revenue, respectively.
For the three months ended September 30, 1999, the Dothan, Alabama and Ft.
Wayne, Indiana areas (comprised of five hospitals) accounted for approximately
34% of owned hospital revenue and 58% of owned hospital EBITDA. EBITDA means our
earnings before interest, minority interest, income taxes, depreciation and
amortization expense and investigation and litigation related costs.
For the three months ended September 30, 1999, our net income before
investigation and litigation related costs was 56% lower than the three months
ended September 30, 1998. We believe this was principally due to the following
issues:
- We experienced increased discounts to insurance and managed
care companies and increased charity care.
- We received lower payments from the government under the
Medicare program as a result of the Balanced Budget Act of
1997 (BBA 97).
- We were unable to contain our costs, including bad debt
expense, in proportion to our revenue growth.
- Our estimated final settlements from the government under
Medicare and Medicaid programs were lower.
- Our share of earnings from joint ventures decreased.
- The hospitals we acquired during the second quarter of fiscal
1999 reduced net income.
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IMPACT OF ACQUISITIONS, JOINT VENTURES AND SALES
In fiscal 1999, we acquired four hospitals and affiliated health care
entities. We also entered into a joint venture in Vicksburg, Mississippi. We
manage and have a controlling interest in the joint venture. Some of these
entities did not perform as well as we initially expected. This was due to some
of the same factors we experienced in our other owned hospitals. Also, we had
difficulties integrating some of the acquired hospitals into our operations. In
fiscal 1999, we sold Park Medical Center in Columbus, Ohio.
Because of the financial impact of acquisitions, joint ventures and
sales, it is difficult to make meaningful comparisons between our financial
statements for the periods presented. Due to the current number of owned
hospitals, each additional hospital we acquire can affect our overall operating
margins or results of operations.
LITIGATION
We are currently, and from time to time expect to be, subject to
claims, suits and investigations arising in the ordinary course of business. We
may not know about investigations or qui tam actions filed against us by private
parties on behalf of the federal or state governments. Plaintiffs in these
matters may request punitive or other damages that may not be covered by
insurance. Except for the litigation described below, we are not currently
involved in any litigation that we believe could have a material adverse effect
on our results of operations or financial position.
False Claims Act Litigation
In June 1993, the Office of the Inspector General of the Department of
Health and Human Services requested information from us in connection with an
investigation involving our procedures for preparing Medicare cost reports. In
January 1995, the United States Department of Justice issued a Civil
Investigative Demand which also requested information from us in connection with
the same investigation. As a part of the government's investigation, several
former and current employees were interviewed. We cooperated fully with the
investigation. We received no communication from the government on this matter
from approximately June 1996 through August 1998.
In August 1998, the government informed us that the investigation was
prompted by a lawsuit filed under the False Claims Act. The suit was filed in
January 1993 by a former employee of a hospital we managed. These lawsuits,
commonly known as qui tam actions, are filed "under seal." That means that the
claims are kept secret until the government decides whether to join the case.
The person who files the lawsuit is called a "relator". At a meeting in
September 1998, we learned from the government that it would likely join in the
case. The government joined the case against us in October 1998. The former
employee's lawsuit named us, our subsidiary Quorum Health Resources,
Columbia/HCA Healthcare Corporation and all hospitals that we or Columbia/HCA
owned, operated or managed from 1984 through 1997, as defendants. The unsealed
complaint, prepared by the relator, alleged that we knowingly
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prepared and caused to be filed cost reports which claimed payments from
Medicare and other government payment programs greater than the amounts due.
In January 1999, we filed motions with the court asking to be separated
from the case against co-defendant Columbia/HCA. The government did not oppose
the motion to separate the cases against us and Columbia/HCA. On February 2,
1999, the government filed an amended complaint. On that date, the government
also filed a notice of non-intervention advising the Court that it would not
proceed on some of the relator's allegations, and that it would not sue
individual managed hospital clients. The government's complaint did not name as
defendants any hospital we managed. It does name us, Quorum Health Resources and
each subsidiary which now owns or has ever owned a hospital. Subsequently, the
court granted our motion to be separated, dismissed us from the case, and
directed plaintiffs to file a new action against us alone. Plaintiffs did so
on February 24, 1999.
The February 24, 1999 complaint alleges that we, on behalf of hospitals
we managed between 1985 and 1995 and hospitals we owned from 1990 to the
present, violated the False Claims Act by filing false Medicare cost reports.
The government asserts that the false claims in the cost reports are reflected
in "reserve analyses" we created. The complaint also alleges that these cost
report filings were prepared as the result of our policy.
In March 1999, as we had requested, the court appointed a mediator to
facilitate settlement discussions between us and the government. Meetings with
the mediator were held on June 11, 1999 and November 4, 1999.
In April 1999, we filed several motions to dismiss the government's
complaint in whole or in part as well as a motion to dismiss the relator from
the case. The government and the relator replied to our motions in June, 1999
and we filed a reply in July, 1999. The court has not ruled on our motions.
This qui tam action seeks three times the amount of damages caused to
the United States by our submission of any alleged false claims to the
government, civil penalties of not less than $5,000 nor more than $10,000 for
each false claim, and attorneys' fees and costs.
Other Qui Tam Actions and Related Investigations
In May 1998, we were informed that we were a defendant in another qui
tam action involving home health services provided by two of our owned hospitals
and alleging that we had violated Medicare laws. This action was filed under
seal in June 1996 by a former employee, whom we fired in April 1996. The United
States Attorney's Office gave us the opportunity to review the results of the
government's investigations and discuss the allegations made in the action prior
to the government making a decision to intervene as a plaintiff. The lawsuit
remains under seal for all other purposes. We have cooperated fully with the
United States Attorney's Office and provided additional information and made
employees available for interviews. We are now engaged in preliminary settlement
discussions with the government.
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<PAGE> 20
As part of our ongoing discussions, we have learned from the same U.S.
Attorney that there are two additional unrelated qui tam complaints against us
alleging Medicare violations at one owned and two managed hospitals. Both
matters remain under seal. We have not seen the complaint in either matter. The
government has told us that it intends to investigate these allegations. We
intend to cooperate with the government's investigation.
The Class and Derivative Actions
In October and November 1998, some of our stockholders filed lawsuits
against us in the U.S. District Court for the Middle District of Tennessee. In
January 1999, the court consolidated these cases into a single lawsuit. (M.D.
Tenn. No. 3-98-1004) The plaintiffs filed an amended complaint in March 1999.
The plaintiffs seek to represent a class of plaintiffs who purchased our common
stock from October 25, 1995 through October 21, 1998, except for our insiders
and their immediate families. The consolidated complaint names us, several of
our officers and one of our outside directors, as defendants.
The complaint alleges that defendants violated the Securities Exchange
Act of 1934. The plaintiffs claim that we materially inflated our net revenues
during the class period by including in those net revenues amounts received from
the settlement of cost reports that had allegedly been filed in violation of
applicable Medicare regulations years earlier and that, because of this
practice, this statement, which first appeared in our Form 10-K filed in
September 1996, was false: "The Company believes that its owned hospitals are in
substantial compliance with current federal, state, local, and independent
review body regulations and standards." In May 1999, we filed a motion to
dismiss the complaint. The plaintiffs have filed papers opposing the motion, and
the judge has not yet ruled on the motion. We intend to defend vigorously the
claims and allegations in this action.
On November 2, 1998, a lawsuit was filed against us, all of our current
directors and two former directors in the U.S. District Court for the Northern
District of Alabama. On January 14, 1999, this suit was transferred by agreement
of the parties to the U.S. District Court for the Middle District of Tennessee.
(M.D. Tenn. No. 3-99-0055) On February 16, 1999, the defendants filed a motion
to dismiss the original complaint. The court then granted the plaintiff
permission to file a first amended complaint, which, when filed, mooted the
original motion to dismiss. On April 30, 1999, the defendants moved to dismiss
the first amended complaint. The court on July 1, 1999, granted plaintiff's
motion for leave to file a second amended complaint and denied as moot the
motion to dismiss the first amended complaint. The second amended complaint
asserts four claims: a shareholders' derivative claim for breach of fiduciary
duty, a shareholders' derivative claim for violations of the Racketeer
Influenced and Corrupt Organizations Act, a shareholders' derivative claim for
injunctive relief, and a purported class action claim for breach of fiduciary
duty. As the basis for each of these claims, plaintiff alleges that the
defendants in 1993 were aware that we were filing allegedly false cost reports
and that the defendants "mandated" that the illegal acts continue in violation
of applicable Medicare and Medicaid laws. The defendants have filed a motion to
dismiss the second amended complaint. The plaintiff has responded
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to this motion, but the court has not yet ruled on this motion. All of the
defendants plan to vigorously defend this litigation.
It is too early to predict the effect or outcome of any of the ongoing
investigations or the qui tam, class or stockholders' derivative actions, or
whether any additional investigations or litigation will be commenced. If we are
found to have violated federal or state laws relating to Medicare, Medicaid or
other government programs, then we may be required to pay substantial fines and
civil and criminal penalties. We also may be excluded from participating in the
Medicare and Medicaid programs and other government programs. Similarly, the
amount of damages sought in the qui tam actions are substantial. We could be
subject to substantial costs resulting from an adverse outcome of any of these
actions. In an effort to promptly resolve one or more of these matters, we may
choose to negotiate a settlement. Amounts we pay to settle any of these matters
may be material. Any one or more of these actions or costs could have a material
adverse effect on our results of operations or financial position (See Note 9 -
Contingencies in the Notes to Condensed Consolidated Financial Statements).
SELECTED OPERATING STATISTICS - OWNED HOSPITALS
The following table sets forth operating statistics for our owned
hospitals for each of the periods presented. Statistics for the three months
ended September 30, 1999 include a full period of operations for twenty-one
hospitals and the joint ventures in which we are minority investors. The results
of the owned hospitals for the three months ended September 30, 1998 include
three months of operations for eighteen hospitals and the joint ventures in
which we are minority investors.
<TABLE>
<CAPTION>
Three Months
Ended
September 30
----------------------
1999 1998
-------- --------
<S> <C> <C>
Number of hospitals 21 18
Licensed beds 4,578 4,217
Beds in service 3,959 3,461
Admissions 34,705 30,522
Average length of stay 5.5 5.5
Patient days 190,340 168,994
Adjusted patient days 328,857 295,678
Occupancy rate (licensed beds) 45.2% 44.0%
Occupancy rate (beds in service) 52.3% 53.7%
Gross inpatient revenue (in thousands) $430,227 $351,963
Gross outpatient revenue (in thousands) $313,091 $263,844
</TABLE>
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RESULTS OF OPERATIONS
The following table reflects the percentage of net operating revenue
represented by various categories in our Condensed Consolidated Statements of
Income for the three months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
Three Months Ended
September 30
-------------------
1999 1998
------ ------
<S> <C> <C>
Net operating revenue 100.0% 100.0%
Operating expenses (1) 84.2 80.9
Equity in earnings of affiliates (0.5) (1.4)
------ ------
EBITDAR (2) 16.3 20.5
Leases and rentals 2.1 1.8
------ ------
EBITDA (2) 14.2 18.7
Depreciation and amortization 6.1 5.5
Interest expense 3.9 2.3
Investigation and litigation
related costs 0.3 --
Minority interest (0.1) 0.2
------ ------
Income before income taxes 4.0 10.7
Provision for income taxes 1.5 4.2
------ ------
Net income 2.5% 6.5%
====== ======
</TABLE>
- ---------------
(1) Operating expenses represent expenses before leases and rentals, interest,
minority interest, income taxes, depreciation and amortization expense, and
investigation and litigation related costs.
(2) EBITDA represents earnings before interest, minority interest, income taxes,
depreciation and amortization expense, and investigation and litigation related
costs. EBITDAR represents EBITDA before leases and rentals. EBITDA and EBITDAR
are commonly used as analytical indicators, and also serve as a measure of
indebtedness capacity and debt service ability. We have included EBITDA and
EBITDAR data because they are typically used by investors to measure a company's
ability to service debt. EBITDA and EBITDAR should not be considered measures of
financial performance under generally accepted accounting principles, and the
items excluded from EBITDA and EBITDAR are significant components in
understanding and assessing financial performance. EBITDA and EBITDAR should not
be considered in isolation or as alternatives to net income, cash flows
generated by operating, investing or financing activities or other financial
statement data presented in the condensed consolidated financial statements as
an indicator of financial performance or
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liquidity. Because EBITDA and EBITDAR are not measurements determined in
accordance with generally accepted accounting principles and are susceptible to
varying calculations, EBITDA and EBITDAR as presented may not be comparable to
other similarly titled measures of other companies.
Three Months Ended September 30, 1999 Compared to Three Months Ended September
30, 1998
Net Operating Revenue. Net operating revenue was $431.3 million for the
three months ended September 30, 1999, compared to $389.4 million for the three
months ended September 30, 1998. This represents an increase of $41.9 million or
10.8%. We attribute this increase to (1) the acquisition of three hospitals in
fiscal 1999, (2) the hospital contributed by Columbia/HCA in fiscal 1999 to a
joint venture that we control and (3) a 0.5% increase in net operating revenue
produced by same store hospitals. "Same store hospitals" was calculated by
comparing the same periods in both fiscal periods for hospitals owned for one
year or more. The increase in net operating revenue was partially offset by the
sale of our Columbus hospital in fiscal 1999 and a 6.1% decrease in revenue from
our hospital management services.
We attribute the 0.5% same store net operating revenue increase
principally to a 1.2% increase in same store admissions and price increases. Our
same store net operating revenue would have increased more, except for (1)
increased discounts to insurance and managed care companies and increased
charity care (2) lower payments from the government under the Medicare program
as a result of BBA 97, including reduced home health payments and (3) decreased
estimated final settlements from the government under Medicare and Medicaid
programs (Estimated third-party payor settlements are discussed under the
caption "General").
Operating Expenses. Operating expenses were $363.2 million for the
three months ended September 30, 1999, compared to $314.7 million for the three
months ended September 30, 1998. This represents an increase of $48.5 million or
15.4%. Operating expenses as a percentage of net operating revenue increased to
84.2% for the three months ended September 30, 1999 from 80.9% for the three
months ended September 30, 1998. Operating expenses as a percentage of net
operating revenue for our owned hospitals was 84.9% for the three months ended
September 30, 1999, compared to 81.5% for the three months ended September 30,
1998. For our same store hospitals, operating expenses as a percentage of net
operating revenue increased to 83.8% for the three months ended September 30,
1999, from 80.5% for the three months ended September 30, 1998. We attribute the
same store hospital increase primarily to our overall difficulty in containing
our costs in proportion to our revenue growth and increases in bad debt expense.
During the three months ended September 30, 1999, we implemented cost
containment programs at our hospitals and our corporate office to reduce costs
and to mitigate the impact of salaries and wage rate pressures and increased
costs associated with new technology and products. We believe our recent
hospital computer conversions have contributed to our increase in bad debt
expense.
Equity in Earnings of Affiliates. Equity in earnings of affiliates
represents our share of earnings from joint ventures in which we hold a
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minority interest. Equity in earnings of affiliates was $2.1 million for the
three months ended September 30, 1999, compared to $5.3 million for the three
months ended September 30, 1998, a decrease of $3.2 million. Equity in earnings
of affiliates represented 0.5% of our net operating revenue for the three months
ended September 30, 1999, compared to 1.4% of our net operating revenue for the
three months ended September 30, 1998. This decrease was due primarily to a
reduction in earnings at our Las Vegas joint venture.
Leases and Rentals. Leases and rentals were $9.1 million for the three
months ended September 30, 1999, compared to $7.1 million for the three months
ended September 30, 1998, an increase of $2.0 million, or 27.0%. Leases and
rentals as a percentage of net operating revenue increased to 2.1% for the three
months ended September 30, 1999, compared to 1.8% for the three months ended
September 30, 1998. This increase was due primarily to an increase in assets
leased under our end loaded lease financing agreement in connection with
hospital acquisitions in fiscal 1999.
EBITDA. EBITDA for the three months ended September 30, 1999 was $61.1
million, compared to $72.9 million for the three months ended September 30,
1998, a decrease of $11.8 million or 16.1%. EBITDA as a percentage of net
operating revenue was 14.2% for the three months ended September 30, 1999,
compared to 18.7% for the three months ended September 30, 1998. EBITDA as a
percentage of net operating revenue for our owned hospitals was 13.5% for the
three months ended September 30, 1999, compared to 18.2% for the three months
ended September 30, 1998. EBITDA as a percentage of net operating revenue for
our same store hospitals was 14.4% for the three months ended September 30,
1999, compared to 17.7% for the three months ended September 30, 1998. EBITDA as
a percentage of net operating revenue for our management services business was
21.7% for the three months ended September 30, 1999, compared to 23.7% for the
three months ended September 30, 1998. We attribute the decrease in consolidated
EBITDA principally to (1) the impact of BBA 97, managed care and decreased payor
settlements (2) overall difficulties in containing our costs, including bad debt
expense, in proportion to our revenue growth and (3) the decrease in equity in
earnings of affiliates.
Depreciation and Amortization. Depreciation and amortization expense
for the three months ended September 30, 1999 was $26.2 million, compared to
$21.3 million for the three months ended September 30, 1998, an increase of $4.9
million, or 22.9%. Depreciation and amortization expense as a percentage of net
operating revenue increased to 6.1% for the three months ended September 30,
1999 from 5.5% for the three months ended September 30, 1998. The increase in
depreciation and amortization as a percentage of net operating revenue was due
principally to the opening of a replacement facility in Florence, South Carolina
and capital costs associated with Year 2000.
Interest Expense. Interest expense for the three months ended September
30, 1999 was $16.7 million, compared to $9.1 million for the three months ended
September 30, 1998, an increase of $7.6 million, or 83.2%. Interest expense as a
percentage of net operating revenue increased to 3.9% for the three months ended
September 30, 1999 from 2.3% for the three months ended September 30, 1998. The
increase was due principally to (1) additional borrowings related to fiscal 1999
acquisitions, share repurchases, and the
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opening of the replacement facility in fiscal 1999, (2) an increase in interest
rates and (3) the termination of two interest rate swap agreements during the
three months ended September 30, 1998.
Investigation and Litigation Related Costs. For the three months ended
September 30, 1999, we incurred investigation and litigation related costs of
approximately $1.1 million.
Minority Interest Income and Expense. Minority interest income was $0.3
million for the three months ended September 30, 1999, compared to expense of
$0.6 million for the three months ended September 30, 1998, a change of $0.9
million. Minority interest income as a percentage of net operating revenue was
0.1% for the three months ended September 30, 1999, compared to expense of 0.2%
for the three months ended September 30, 1998. We attribute this change
primarily to two markets, one of which is newly acquired and has low volumes and
one with increased bad debt expense.
Income Taxes. The provision for income taxes for the three months ended
September 30, 1999 was $6.8 million compared to $16.4 million for the three
months ended September 30, 1998, a decrease of $9.5 million, or 58.3%. The
provision for income taxes as a percentage of net operating revenue decreased to
1.5% for the three months ended September 30, 1999, from 4.2% for the three
months ended September 30, 1998. Our effective income tax rate was 39.1% for
both periods.
Net Income. Net income for the three months ended September 30, 1999
was $10.6 million, compared to $25.5 million in fiscal 1998, a decrease of $14.9
million, or 58.3%. Net income as a percentage of net operating revenue was 2.5%
for the three months ended September 30, 1999, compared to 6.5% for the three
months ended September 30, 1998. Excluding investigation and litigation related
costs, net income as a percentage of net operating revenue was 2.6% for the
three months ended September 30, 1999, compared to 6.5% for the three months
ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, our working capital was $230.3 million. Our
ratio of current assets to current liabilities was 2.1 to 1.0 at September 30,
1999 and June 30, 1999.
Our principal sources of cash are net cash provided by operating
activities and cash available under our bank revolving line of credit facility.
Our principal uses of funds are hospital acquisitions, capital expenditures,
payments of principal and interest on our long-term debt and share repurchases.
The billing and collection of accounts receivable by hospitals is very
difficult because of the complexity of the Medicare and Medicaid regulations,
increases in managed care, hospital personnel turnover including business office
managers, computer system conversions by hospital and government authorities,
dependence of hospitals on physician documentation of medical records, and the
subjective judgement involved in submitting Medicare and
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<PAGE> 26
Medicaid bills. There can be no assurance that this complexity will not
negatively impact our future cash flow or results of operations.
Three Months Ended September 30, 1999 Cash Flows Compared To Three Months
Ended September 30, 1998 Cash Flows
Cash provided by operating activities totaled $48.7 million for the
three months ended September 30, 1999, compared to $31.0 million for the three
months ended September 30, 1998, an increase of $17.7 million, or 57.1%. This
increase was due primarily to increased cash collections on accounts receivable
and $14.2 million in cash distributions received from our Macon and Las Vegas
joint ventures. This increase was partially offset by higher tax payments and
payments on accounts payable for the three months ended September 30, 1999 over
the three months ended September 30, 1998.
Capital Expenditures
Capital expenditures excluding acquisitions for the three months ended
September 30, 1999 totaled $22.0 million. We expect to make routine capital
expenditures, including Year 2000 capital costs, for fiscal 2000 of
approximately $100 million before acquisitions of hospitals and affiliated
health care entities.
Capital expenditures excluding acquisitions for the three months ended
September 30, 1998 totaled $31.0 million. These capital expenditures consisted
of the construction of a replacement hospital and two medical office buildings
in Florence, South Carolina of approximately $11.0 million and routine capital
expenditures in the amount of $20.0 million.
Capital Resources
Our revolving credit facility consists of an $850.0 million secured
credit facility expiring November 26, 2002, which coincides with the expiration
date of the end loaded lease facility. On November 26 of each year, we can
request an incremental one-year extension, which is subject to approval of all
of the lenders. The credit facility bears interest at our option at generally
the lender's base rate, swing-line rate or a fluctuating rate ranging from .55
to 1.55 percentage points above LIBOR. Also, we pay a facility fee ranging from
.20 to .45 percentage points on the commitment. The interest rate margins and
facility fee rates are based on our leverage ratio. Substantially all stock of
our subsidiaries has been pledged under the terms of the credit facility. We may
prepay the amount outstanding at any time. At October 31, 1999, we had $287.5
million available under our credit facility.
We also have a $150.0 million end loaded lease financing agreement to
provide a financing option for acquisition and/or construction. This agreement
provides for interest rate margins and facility fee rates that are substantially
similar to those under our credit facility. Under this agreement, we have
guaranteed all lease payments, including contingent lease payments, of up to 85%
of the amount utilized under this agreement. At October 31, 1999, $5.3 million
was available under this agreement.
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We have $150.0 million of 8 3/4% senior subordinated notes, which
mature on November 1, 2005. We have the option to redeem these notes at 104.375%
of the principal amount on or after November 1, 2000, at 102.188% of the
principal amount on or after November 1, 2001, or at par value on or after
November 1, 2002. Upon a change of control, we must make an offer to purchase
these notes at 101% of the principal amount. These notes are unsecured and
subordinated in right of payment to all existing and future senior debt.
Sale of Convertible Subordinated Debentures. On August 31, 1999, we
issued $150.0 million of convertible subordinated debentures due 2009 to Welsh,
Carson, Anderson & Stowe, VIII, LP and certain WCAS VIII affiliates, including
Russell L. Carson, Chairman of our Board of Directors. We sold the debentures
for cash at their face value. The debentures bear interest at 6.0% per annum.
Interest is payable quarterly. The debentures are convertible into common shares
at a conversion price of $11.25 per share. The debentures will automatically
convert at any time after three years if the average of the closing price of our
stock over any 90 day period is more than 150% of the conversion price. We can
call the debentures at par after August 31, 2001. In the event of a merger,
consolidation or sale of more than 50% of our assets, the holder of the
debentures has the option to have the debentures prepaid in full. The debentures
have antidilution protection, including, under certain circumstances, issuance
of common stock below the then applicable conversion price. The shares into
which the debentures are convertible have certain voting restrictions and must
be held for a two-year period beginning August 1999. The debentures are
subordinated in right of payment to all our debt. We did not register the
debentures under the Securities Act of 1933. The sale of the debentures was
exempt from registration under Section 4(2) of the Securities Act because it was
a privately negotiated transaction and did not involve a public offering. We
used the proceeds to reduce our outstanding debt under our revolving credit
facility.
The credit facilities governing our revolving line of credit and
subordinated notes contain certain financial covenants including but not limited
to a limitation on debt levels, the prohibition of dividend payments and other
distributions and restrictions on investments, repurchases of common stock,
asset dispositions, the ability to merge or consolidate with or transfer assets
to another entity, and the maintenance of various financial ratios, including a
net worth ratio, a fixed charge ratio and a leverage ratio.
From October 1 through November 3, 1999 we repurchased 2.6 million
shares of our common stock for an aggregate purchase price of $17.3 million. We
repurchased all of these shares in open market transactions. There are
approximately 1.8 million shares remaining for repurchase under the existing
five-million-share repurchase program authorized in October 1998.
As of October 31, 1999, there were 5.8 million options outstanding with
a weighted average exercise price of $9.60. In March 1999, our board of
directors approved a plan to allow all employees to exchange "underwater" stock
options. These stock options had exercise prices higher than the market price of
our common stock. Based on the exchange, we canceled 5.2 million options at
exercise prices ranging from $12.09 to $33.06 and issued 3.6 million options at
an exercise price of $9.00. The effect was to reduce the number of options held
to offset the benefit of a lower exercise price. The estimated economic value of
the grants was generally unchanged as a result of the exchange. Under the
proposed interpretation of APB Opinion No. 25, repriced options would receive
variable-award accounting. Should we be required to apply variable-award
accounting to the repriced options, such options will
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vest and terminate thirty days after we give notice to our employees. Variable
award accounting will be eliminated after the option termination date. During
this thirty day period, variable award accounting could cause an increase in our
compensation expense.
We adopted a stockholder rights plan in fiscal 1997 and declared a
dividend of one right for each share of common stock. The plan was amended in
August 1999. Each right entitles stockholders to acquire one-third of a share of
common stock at an exercise price of $100, subject to adjustment. The rights
become exercisable only if (1) Welsh, Carson, Anderson & Stowe VIII, L.P., WCAS
Management Corporation and certain parties which purchase the convertible
debentures from these entities acquire beneficial ownership of 30% or more of
our common stock or start an offer which would result in those entities owning
30% or more of our common stock or (2) any other person or group acquires
beneficial ownership of 15% or more of our common stock or starts an offer which
would result in that person or group owning 15% or more of our common stock. At
that time, each right owned by unaffiliated others entitles its holder to
purchase common stock (or any combination of common stock, preferred stock, debt
securities and cash, as determined by our board of directors) worth two times
the exercise price of the right. If we are involved in a business combination
transaction with another person or if we sell 50% or more of our assets or
earning power to another person, each right entitles its holder to purchase
shares of our common stock or the acquiring company's common stock worth two
times the exercise price of the right. We may redeem the rights for $.01 each at
any time until the tenth day following public announcement that an ownership
position as described above has been acquired. The rights expire on April 28,
2007.
SEASONALITY AND INFLATION
Our business is seasonal, with higher patient volumes and net operating
revenues in the third quarter of our fiscal year than in the remainder of the
year. This seasonality happens because more people get sick during the winter,
which in turn increases the number of patients in our owned hospitals.
The health care industry is labor intensive. This means that our owned
hospitals need many employees, who we pay salaries and other benefits. These
salaries and benefits increase during periods of inflation and shortages of
qualified potential employees. In addition, our suppliers pass along rising
costs to us in the form of higher prices. As discussed earlier, for the three
months ended September 30, 1999, we were not able to contain our costs in
proportion to our revenue growth. We cannot assure you that we will be able to
offset or control future cost increases.
MARKET RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS
Our interest expense is sensitive to changes in the general level of
interest rates. To mitigate the impact of fluctuations in interest rates, we
generally maintain 50%-75% of our debt at a fixed rate, either by borrowing on a
long-term basis or entering into interest rate swaps. Interest rate swaps are
contracts which allow us to periodically exchange fixed and floating interest
rate payments over the life of the agreements.
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<PAGE> 29
Floating-rate payments are based on LIBOR and fixed-rate payments are dependent
upon market levels at the time we execute the swap agreement. Our policy is to
not hold or issue derivatives for trading purposes and to avoid derivatives with
leverage features. Some of our swap agreements allow the counter party a
one-time option at the end of the initial term to cancel the agreement or a
one-time option at the end of the initial term to extend the swaps for an
incremental period of up to five years. If our counter parties do not comply
with their obligations under our financial instruments, we may suffer losses.
Our counter parties are creditworthy financial institutions and we anticipate
that they will be able to fully satisfy their obligations under the contracts.
For the three months ended September 30, 1999 and 1998, we received a weighted
average rate of 5.2% and 5.7% and paid a weighted average rate of 5.9% and 5.8%,
respectively.
The following table presents information about our market-sensitive
financial instruments, including long-term debt and interest rate swaps as of
September 30, 1999. For debt obligations, the table presents principal cash
flows and related weighted-average interest rates by expected maturity dates.
For interest rate swap agreements, the table presents notional amounts by
expected maturity date (assuming the options to extend or cancel are not
exercised) and weighted average interest rates based on rates in effect at
September 30, 1999. The fair values of long-term debt and interest rate swaps
were determined based on quoted market prices at September 30, 1999 for the same
or similar issues.
Maturity Date, Fiscal Year Ending June 30
(Dollars in millions)
<TABLE>
<CAPTION>
September 30,
1999
There- Fair Value of
2000 2001 2002 2003 2004 after Total Liabilities
------ ------ ------ ------ ------ ------ ------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long-term debt:
Fixed rate long-term
debt $ 0.7 $ 0.8 $ 0.6 $ 0.6 $ 0.6 $301.6 $304.9 $291.4
Average interest rates 7.6% 7.7% 7.7% 7.7% 7.8% 7.4%
Variable rate long-
term debt $ 539.7 $539.7 $539.7
Average interest rates 6.5%
Interest rate swaps:
Pay fixed/receive
variable notional
amounts $400.0 $400.0 $ (1.3)
Average pay rate 5.9%
Average receive rate 5.5%
</TABLE>
29
<PAGE> 30
YEAR 2000 ISSUES
The "Year 2000 problem" refers to the inability of computers and
related software to correctly interpret and process Year 2000 dated
transactions. This occurs because some computer programs and embedded-chip
systems use two digits instead of four to define the applicable year. Computer
systems that are not Year 2000 compliant may not process data accurately for
transactions dated after the year 1999. Any of our computer programs,
embedded-chip systems, building infrastructure components or medical devices
that have date sensitive software may recognize "00" as the year 1900 rather
than the year 2000. Our computer programs, embedded-chip systems or equipment,
and medical devices could fail if we do not correct this problem in time. This
could in turn disrupt our business operations or affect patient diagnosis and
treatment.
Our Year 2000 strategy is led by our Vice President of Corporate
Services. As part of our strategy, in July 1998, we retained an external firm to
provide consulting services and to assist us in implementing our Year 2000
strategy. We have a Year 2000 steering committee to assist us in implementing
our Year 2000 strategy. Our Year 2000 strategy addresses our owned and managed
hospitals and our corporate offices.
Owned Hospitals and Corporate Office
Our owned hospitals and the corporate office Year 2000 strategy
includes phases for education, inventory and assessment, validation (including
testing) and conversion/remediation/replacement. We are also developing
contingency plans to address potential disruption of operations arising from the
Year 2000 problem.
Education. We have completed the education phase of our Year 2000
strategy. Education will continue to be provided throughout the Year 2000
implementation process.
Inventory and Assessment. We have substantially completed the inventory
and assessment phase of our Year 2000 strategy.
Testing and Remediation.
Tier Approach - Owned Hospitals. We have adopted a "tier approach" for
Year 2000 project completion. Tier 1 addresses applications and equipment that
have a direct impact on patient safety and health or are essential to our daily
operations. Tier 2 represents applications and equipment that are critical to
continued business operations, but not required to provide day-to-day service to
the patients and for which a viable alternative exists. Tier 3 indicates
applications and equipment not essential to our daily operations.
We have given first priority in our testing and remediation efforts to
date to Tier 1 applications and equipment as described below. However, we are
also currently validating and remediating Tier 2 devices, components and
systems. In addition to our own testing, we are also using an outside vendor to
gather and
30
<PAGE> 31
monitor manufacturer Year 2000 compliance information of biomedical devices,
building infrastructure components and information systems. In general, we are
relying on vendor verification of Year 2000 compliance for Tier 2 devices,
components and systems, rather than testing these items.
Financial Application Software and Hardware - Owned Hospitals. Third
parties supply and support the financial application software used in our owned
hospitals in such areas as patient accounting and financial reporting. We use
very little in-house developed software. Nineteen hospitals have been advised by
the manufacturers of our financial software systems that such software is
substantially Year 2000 compliant. We have scheduled an upgrade of the financial
systems for the two remaining hospitals (which share one system) to be completed
by early December 1999.
The vendors of our owned hospitals' financial application software have
tested the standard versions of their software. We have discussed with the
vendors their testing procedures and test results, and considered their written
representation of Year 2000 compliance. We believe that the vendors have
sufficiently tested the standard software. Some of our hospitals have customized
the standard software. We have reviewed these customizations, and we believe
they will not adversely affect the basic operations of the standard software. In
addition, all of our hospitals have interfaces which permit information to be
transferred among different software programs and computer equipment. We have
completed an evaluation of these interfaces, and we believe that no further
testing or remediation is required.
Clinical and Other Software and Hardware - Owned Hospitals. We also use
clinical software and hardware such as laboratory and pharmacy systems and
related computer equipment in our owned hospitals. We have substantially
completed testing and validation of all computer equipment which we have
designated as Tier 1 systems. For Tier 1 clinical software and hardware which
cannot be tested without taking it out of service, we have followed a process
similar to that outlined above for verifying Year 2000 readiness for financial
application software. We believe that approximately 95% of the Tier 1 systems
requiring Year 2000 validation are Year 2000 compliant. We currently expect to
complete remediation of the remaining 5% by the end of 1999. We have verified
with the manufacturer the Year 2000 status of over 75% of our Tier 2 software
and hardware. The remaining Tier 2 items consist primarily of personal computers
and related software and hardware. These items are scheduled to be validated,
and remediated where necessary, by the end of 1999.
Biomedical Equipment and Building Infrastructure - Owned Hospitals. We
have substantially completed testing and validation of all Tier 1 biomedical
equipment. We have not tested devices where the manufacturer has advised us
against testing such equipment and represented Year 2000 compliance in writing.
We believe that approximately 98% of the Tier 1 devices requiring Year 2000
validation are now Year 2000 compliant. We currently expect to complete
remediation for the remaining 2% by the end of 1999. Our policy is that we will
not use any Tier 1 biomedical device without reasonable assurance that it will
perform properly in light of the Year 2000 problem. Such assurance may take the
form of testing, vendor assurances of Year 2000 compliance or, where feasible,
developing a work around procedure for the device in case of a
31
<PAGE> 32
possible malfunction. We believe that approximately 96% of our Tier 2 biomedical
equipment is Year 2000 compliant. The remaining 4% is scheduled to be
validated, and remediated where necessary, by the end of 1999.
We have substantially completed testing and validation of all Tier 1
building infrastructure components of our owned hospitals. Remediation has been
ongoing during the testing phase. We believe that approximately 96% of the Tier
1 components requiring Year 2000 validation are now Year 2000 compliant (revised
from our earlier expectation of reaching 99% by October 1999). We currently
expect the remaining 4% (comprising 16 components) to be completed by early
December 1999. We believe that approximately 90% of the Tier 2 building
infrastructure components are Year 2000 compliant. The remaining 10% is
scheduled to be validated, and remediated if necessary, by the end of 1999.
Corporate Office. We believe that our corporate office network is
substantially Year 2000 compliant. We have been advised by the manufacturer that
the financial software applications used by our corporate office are
substantially Year 2000 compliant. We have substantially completed the
education, inventory, remediation and testing phases with respect to other
corporate office and satellite office computer equipment, including desktop
computers and building infrastructure.
Managed Hospitals
In December 1998, we notified the owners of our managed hospitals that
we did not have the necessary expertise to assist hospitals with their Year 2000
problem. We advised the owners of our managed hospitals that they should engage
outside consultants to assist them in their Year 2000 compliance efforts. We
also recommended that each managed hospital create a Year 2000 committee charged
with the design, implementation and day-to-day oversight of the managed
hospital's Year 2000 compliance efforts, and that the governing body of each
managed hospital receive regular monthly reports from its Year 2000 committee.
We have distributed educational materials about the Year 2000 problem to the
owners of our managed hospitals. We monitor the progress of the response of our
managed hospitals to the Year 2000 problem by asking them to report to us the
status of their Year 2000 strategy. We do not independently verify their
reports. We have also identified third-party resources which our managed
hospitals may choose to use to assist them in addressing their Year 2000
problem.
We believe we are not responsible for ensuring the Year 2000 compliance
of our managed hospitals. We are not able to verify the status of remediation
efforts at our managed hospitals. Therefore, we are not able to evaluate the
most reasonably likely Year 2000 worst case scenario for our managed hospitals.
Because we provide only management services, we do not pay the expenses of our
managed hospitals and, therefore, we do not expect to incur any significant Year
2000 remediation costs for our managed hospitals. We cannot assure you that our
managed hospitals will not seek to hold us responsible for losses they incur
arising out of their Year 2000 problem. Nor can we assure you that we will not
ultimately be found liable for the losses which, if they occur, may be
material.
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<PAGE> 33
Reliance on Third Parties
We rely heavily on third parties in operating our business. In addition
to our reliance on software, hardware and other equipment vendors to verify the
Year 2000 compliance of their products, we also depend on (1) fiscal
intermediaries which process claims and make payments for the Medicare and
Medicaid programs, (2) insurance companies, managed care entities and other
third party payors, (3) third party processors which submit our Medicare claims
for payment, (4) utilities which provide electricity, water, gas and telephone
services and (5) vendors of medical supplies and pharmaceuticals used in patient
care. We are contacting the most critical third parties to determine whether
they believe they are Year 2000 compliant and if not, the extent to which our
operations may be adversely affected. We will modify contingency plans as
necessary. In its June 30, 1999 Quarterly Progress Report, the Health Care
Financing Administration stated that all of its 25 internal mission critical
systems and 75 mission critical external claims processing systems were Year
2000 compliant. We are seeking assurances from fiscal intermediaries, third
party claims processors, and other payors that their systems are Year 2000
compliant. Substantially all payors representing 10% or more of each owned
hospital's revenues have provided assurance that they are Year 2000 compliant.
We expect this process to continue through the remainder of 1999. We cannot
assure you that the systems or products of third parties on which we rely will
be converted on a timely basis or that their failure to become Year 2000
compliant would not have a material adverse effect on our results of operations
or financial condition.
Costs to Address Year 2000 Issue
We currently estimate that the total cost to implement our Year 2000
strategy will be about $20.0 million. This does not include payroll costs for
certain internal employees because we do not separately track these costs. It
also does not include the costs of implementing contingency plans, if required.
We incurred approximately $2.7 million in operating costs and $5.4 million in
capital costs during the first six months of calendar 1999. We also incurred
$0.5 million in operating costs and $0.7 million in capital costs during the
three months ended September 30, 1999. Prior to this time, we were not able to
reasonably estimate our Year 2000 costs incurred. We believe that 90% to 95% of
the remaining costs will be capital costs. We set aside a portion of our fiscal
2000 capital budget as Year 2000 costs and expect that substantially all of our
Year 2000 capital costs can be accommodated within our budget. All cost
estimates are preliminary and are expected to be revised as the project
progresses. There can be no guarantees that these estimates will be achieved and
actual results could differ materially from those anticipated.
Worst Case Scenarios
We believe that the most reasonably likely worst case scenarios would
involve (1)malfunctions in clinical computer software and hardware at our owned
hospitals, (2)malfunctions in biomedical equipment at our owned hospitals,
(3)temporary disruptions in the delivery of medical supplies and utility
services to our owned hospitals and (4)temporary disruptions in payments to our
owned hospitals. Any of these worst case scenarios could materially disrupt
33
<PAGE> 34
our business and operations. In addition, if any of these things occur, we will
have increased costs, as the affected hospital will have to refer patients and
procedures to other health care providers, contact alternative suppliers and
increase staffing to assure adequate patient care. We could also lose revenue
for procedures which our hospitals are unable to perform. For example, our
hospitals plan to suspend a service if Year 2000 compliant equipment required
for that service is unavailable. Our cash flow will be adversely affected if we
experience disruptions in payments. We are basing the above assessment on
information currently available to us. Our actual results may differ materially.
Contingency Plans
We have developed contingency plans in all of our owned hospitals and
corporate office that we believe will reduce disruption in service that may be
caused by the Year 2000 problem. As part of our contingency plan, each of our
owned hospitals has a disaster plan, which we review regularly. These disaster
plans are designed to enable the hospital to continue to function during natural
disasters and other crises. The plans contemplate moving patients to other
facilities if the hospital is not able to continue to care for them. In some
cases, we may not be able to develop contingency plans which allow the hospital
to continue to operate. For example, the affected hospital may not be able to
secure supplies of fuel to operate its backup generators if electrical supplies
fail for an extended period. We have reviewed, revised and are now undergoing a
second review of our owned hospital contingency plans. We plan to test our
contingency plans in November 1999. Outcomes of the test will be used to improve
our contingency plans.
Risks of Year 2000 Issues
We can provide no assurances that applications and equipment we believe
to be Year 2000 compliant will not experience difficulties, that Year 2000
issues will not arise that we did not contemplate or erroneously assigned a low
level of risk, or that we will not experience difficulties obtaining resources
needed to make modifications to or replace affected systems and equipment.
Failure by us or third parties on which we rely to resolve Year 2000 issues
could have a material adverse effect on our results of operations and our
ability to provide health care services. Consequently, we can give no assurances
that issues related to Year 2000 will not have a material adverse effect on our
financial condition or results of operations. Our Year 2000 readiness program is
an ongoing process and the risk assessments and estimates of costs and
completion dates for various phases of the program are subject to change. The
projected cost of the Year 2000 program and the dates on which we believe the
phases of the program will be completed are based on our best estimates, which
were derived using numerous assumptions of future events. Factors that could
cause such changes include availability of qualified personnel and consultants,
the actions of third parties and changes in governmental regulations. We can
give no guarantee that these estimates will be achieved and actual results could
differ materially from those anticipated.
34
<PAGE> 35
GENERAL
We received from the Medicare and Medicaid programs approximately 54%
and 55% of gross patient service revenue for the years ended June 30, 1999 and
1998, respectively.
Under BBA 97, there were no increases in the inpatient operating
payment rates to acute care hospitals for services from October 1, 1997 through
September 30, 1998. Inpatient operating payment rates increased 0.5% for October
1, 1998 through September 30, 1999 and 1.1% for October 1, 1999 through
September 30, 2000. These increases are less than inflation and subsequent
increases are also expected to be less than inflation. Also, the threshold to
qualify for additional payments for treating costly inpatient cases (outliers)
increased, resulting in decreased payments to hospitals effective October 1,
1999. BBA 97 reduced inpatient capital payments in the aggregate by
approximately 15% effective October 1, 1997. Payments for Medicare outpatient
services, home health services and skilled nursing facility services
historically have been paid based on costs, subject to certain adjustments and
limits. BBA 97 requires that the payment for those services be converted to
prospective payment systems (PPS). PPS for skilled nursing facilities began for
cost reporting periods beginning on and after July 1, 1998. The Health Care
Financing Administration's current plan is to implement PPS for outpatients by
July 1, 2000 and for home health on October 1, 2000.
We experienced reductions in payments for outpatient services and home
health visits because of changes in Medicare payments during the interim period
prior to implementation of PPS. We also experienced reductions in payments under
PPS for skilled nursing facilities. The reduction in home health payments
resulted in a decline in our home health volumes of 14.1% and 53.4% for the
three months ended September 30, 1999 and September 30, 1998, respectively,
compared to the prior year periods. In response to BBA 97, we have consolidated
certain home health agencies and skilled nursing facilities, reduced costs at
our home health agencies and skilled nursing facilities and ceased admitting
patients to skilled nursing facilities at two hospitals.
The federal government now estimates that BBA 97 will reduce health
care spending by approximately double the government's original estimate. BBA 97
has reduced our ability to maintain our historical rate of net revenue growth
and operating margins. We believe the most significant payment reductions were
phased in by October 1, 1998. BBA 97 and further changes in the Medicare or
Medicaid programs and other proposals to limit health care spending could have a
material adverse impact upon the health care industry and our hospitals. We
expect continuing pressure to limit expenditures by governmental health care
programs.
We are continuing to experience an increase in managed care. Managed
care includes indemnity insurance and employer plans which pay less than full
charges, health maintenance organizations, preferred provider organizations and
various other forms of managed care. An increasing number of payors are actively
negotiating amounts paid to hospitals, which are lower than the hospitals'
standard rates. Additionally, some managed care payors pay less
35
<PAGE> 36
than the negotiated rate which, if undetected, results in lower net revenues. To
assist the owned hospital management teams in evaluating and negotiating
contracts and obtaining better pricing, we employ managed care experts. In
several markets, we have canceled contracts with PPOs who allow discounts we
believe are not justified. We are reviewing other markets for similar activity.
Additionally, we plan to install managed care information systems in our owned
hospitals during calendar year 2000 to improve the information available to
management and to help ensure that we are paid at the contracted amounts. The
trend toward managed care has and may continue to adversely affect our ability
to grow net operating revenue and improve operating margins.
Our acute care hospitals, like most acute care hospitals in the United
States, have significant unused capacity. The result is substantial competition
for patients and physicians. Inpatient volumes continue to be negatively
affected by payor-required pre-admission authorization and by payor pressure to
maximize outpatient and alternative health care delivery services for less
acutely ill patients. Over the long term, we expect the industry trend from
inpatient to outpatient services to continue due to the increased focus on
managed care and advances in technology. We also expect increased competition
and admission constraints to continue. The ability to successfully respond to
these trends, as well as spending reductions in governmental health care
programs, will play a significant role in determining our ability to grow net
operating revenue and improve operating margins.
Outpatient revenue of our owned hospitals was approximately 42.1% and
42.8% of gross patient service revenue for the three months ended September 30,
1999 and 1998, respectively.
Until fiscal 1999, our historical financial trend has been favorably
impacted by our ability to successfully acquire acute care hospitals. During
fiscal 1999, our recent acquisitions were affected by many of the same issues as
our same store hospitals. As a result, the financial performance of our recent
acquisitions adversely affected our operating margin and results of operations.
We face competition in acquiring hospitals from a number of well-capitalized
organizations. Recent national studies indicate that acute care hospital margins
peaked in 1998 and are expected to decline for the next several years. The
pricing expected by hospital sellers may not yet reflect lower margins.
Additionally, some hospitals are sold through an "auction" process, which may
result in competitors paying higher prices for those properties than we believe
is reasonable. The Year 2000 problem may reduce the number of suitable hospital
acquisition candidates. Many states have implemented review processes by the
Attorneys General of not-for-profit hospital acquisitions, resulting in delays
to close an acquisition. We believe that trends in the health care industry
described above may create possible future acquisition opportunities. In light
of changes in payments from Medicare and managed care payors, increased pricing
pressures for acquired hospitals and the substantial number of transactions
completed in fiscal 1999, we intend to be selective in pursuing acquisitions.
There can be no assurances that we can continue to grow through hospital
acquisitions and successfully integrate acquired hospitals into our system.
In accordance with generally accepted accounting principles, we
estimate settlements with third party payors. These estimates are based on
assumptions and affect the amounts we report in our financial statements. For
example, we
36
<PAGE> 37
report net patient service revenue at net amounts we expect to receive from our
hospital patients, third party payors, and others for services rendered,
including estimated retroactive adjustments under agreements with third party
payors. We make estimates of settlements under agreements with third party
payors in the period we provide the related services. We then adjust the
settlements as final settlements are determined or additional information is
obtained from the third party payor. Our quarterly or annual operating results
fluctuate based on the timing and amount of changes in estimates.
The IRS is examining our federal income tax returns for fiscal years
1993 through 1998. The IRS has proposed to adjust our federal income tax returns
for fiscal years 1993 through 1995. The most significant adjustments relate to
how we compute bad debt expense and how we value property, plant and equipment
of hospitals we acquire and their related depreciable lives. We have protested
substantially all of the proposed adjustments through the appeals process of the
IRS. In our opinion, the ultimate outcome of the IRS examinations will not have
a material effect on our results of operations or financial condition.
In 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This standard will require us to
recognize all derivatives on the balance sheet at their fair value. Derivatives
that are not hedges must be adjusted to fair value through changes to our income
statement. For interest rate swap agreements that qualify as hedges, we will
offset changes in fair value against the change in fair value of the hedged
assets, liabilities, or firm commitments through changes to our earnings. We
will adopt this new FASB standard on July 1, 2000. We are presently evaluating
the new standard to determine its effect on our earnings and financial position.
On March 31, 1999, the FASB released a proposed interpretation of APB
Opinion No. 25 "Accounting for Certain Transactions involving Stock
Compensation". This proposed interpretation requires variable-award accounting
for repriced stock options. This proposed interpretation would be effective upon
issuance. The expected issuance date has been delayed to the first calendar
quarter of 2000. The interpretation would generally cover events that occur
after December 15, 1998. No adjustments would be made to financial statements
for periods prior to the effective date and no expense would be recognized for
any additional compensation costs attributable to periods before the effective
date (See "Capital Resources" for a discussion of our option repricing completed
in March 1999).
37
<PAGE> 38
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information contained in Part I, Item 2 "Management's Discussion
and Analysis", under the caption "Litigation", is incorporated by reference in
its entirety into this Item 1.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Sales of Unregistered Securities.
The information contained in Part I, Item 2 "Management's Discussion
and Analysis", under the paragraph captioned "Sale of Convertible Subordinated
Debentures", is incorporated by reference in its entirety into this Item 2.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits. The exhibits filed as part of this Report are listed in
the Index to Exhibits immediately following the signature page.
(b) No reports on Form 8-K were filed during the quarter ended
September 30, 1999.
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.
QUORUM HEALTH GROUP, INC.
Date: November 12, 1999 By: /s/ Terry A. Rappuhn
------------------------------------
Terry A. Rappuhn
Senior Vice President/
Chief Financial Officer
<PAGE> 39
Exhibit Index
Exhibit No.
- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30, 1999 AND THE
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF INCOME FOR THE QUARTER ENDED
SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 16,562
<SECURITIES> 0
<RECEIVABLES> 418,204
<ALLOWANCES> 87,230
<INVENTORY> 39,344
<CURRENT-ASSETS> 442,007
<PP&E> 1,153,479
<DEPRECIATION> 320,317
<TOTAL-ASSETS> 1,820,964
<CURRENT-LIABILITIES> 211,757
<BONDS> 843,669
0
0
<COMMON> 732
<OTHER-SE> 634,677
<TOTAL-LIABILITY-AND-EQUITY> 1,820,964
<SALES> 0
<TOTAL-REVENUES> 431,285
<CGS> 0
<TOTAL-COSTS> 330,552
<OTHER-EXPENSES> 26,948
<LOSS-PROVISION> 39,610
<INTEREST-EXPENSE> 16,730
<INCOME-PRETAX> 17,445
<INCOME-TAX> 6,821
<INCOME-CONTINUING> 10,624
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 10,624
<EPS-BASIC> 0.15
<EPS-DILUTED> 0.14
</TABLE>
